Tech Funds’ Record Cash Injection Is Traced To ‘Messy’ Rebalance

(Bloomberg) -- On the surface, technology-focused stock funds just enjoyed a week of record inflows, the latest sign of the AI craze. A look under the hood, however, showed almost all the money went into a single fund — and it had little to do with the industry’s fundamentals. 

The Technology Select Sector SPDR Fund (ticker XLK) attracted more than $8 billion of fresh money during the week through Wednesday, accounting for the bulk of the inflows into the sector, according to data compiled by EPFR. The fund also made up a third of the total inflows to US equities, the data shows. 

The sudden spike came right before XLK’s widely watched quarterly rebalance, in which more than $10 billion of Apple Inc. shares are estimated to be sold to make room for Nvidia Corp. The huge inflow is likely part of a transaction where the fund is looking to get rid of Apple shares that have appreciated in value, without incurring taxes, according to Todd Sohn, managing director of ETF and technical strategy at Strategas Securities. 

A practice that’s fairly common within the ETF industry known as a heartbeat trade, inflows and outflows are made via a market maker who by design swaps assets for shares rather than transacting in cash. With a heartbeat, a friendly bank is pumping extra assets into a given fund so that extra withdrawals can be made — allowing more equity gains to be washed out.

“ETFs have the in-kind mechanism as their secret power,” said Sohn. “Every quarter the flows data gets real messy because of this — just huge numbers on both sides for a few days.” 

State Street Global Advisor, which oversees XLK, didn’t immediately respond to an email seeking comment. The fund’s underlying benchmark, designed by S&P Dow Jones Indices, is scheduled to carry out its quarterly rebalance at Friday’s close.

With Nvidia catching up to Apple and Microsoft Corp. in size during recent weeks, the shuffling in XLK holdings has garnered Wall Street interest given the prospect of volatility-inducing weight additions and reductions to some of the world’s most closely watched tech companies. 

Thanks to diversification rules, XLK has held way fewer Nvidia shares for months despite a market-crushing rally. The expected inflow from the rebalance provides a tailwind for the chip pioneer that’s large for technical-flow standards but modest for a company that’s added trillions to its value. After a 174% rally this year through Tuesday, shares of Nvidia have since dropped more than 6%. 

XLK is likely to experience big outflows as a second part of the heartbeat trade, according to Mohit Bajaj, director of ETFs at WallachBeth Capital.

“There will be a redeem hitting soon today or Monday,” he said. 

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