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NEW YORK (TheStreet) -- A client recently asked why


(AAPL) - Get Apple Inc. Report

was not in the portfolio. That presented a good opportunity to explain the role that sector ETFs play in a diversified portfolio, how what is under the hood of any ETF is very important and that the client does indeed own Apple by virtue of its large weighting in the tech sector ETF in his portfolio.

Just about every large ETF provider has a broad tech sector ETF and Apple is the largest holding by far in all of them.

In the iShares DJ US Technology Sector Index Fund

(IYW) - Get iShares U.S. Technology ETF Report

Apple currently has a 22.7% weight. In the

Technology Select Sector SPDR

(XLK) - Get Technology Select Sector SPDR Fund Report

Apple has a 19.7% weighting and in the

Vanguard Information Technology ETF

(VGT) - Get Vanguard Information Technology ETF Report

it has a 14.5% weight.

The huge weighting in one stock, in this case Apple, is neither bad nor good. It simply reflects the fact that Apple has by far the largest market capitalization. The huge weighting does require having some sort of opinion on Apple; it would make no sense to own any of these ETFs while at the same time believing Apple was destined to go out of business quickly.

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The technology sector currently comprises 20% of the

S&P 500

. An investor who benchmarks to the S&P 500 might reasonably allocate 18% to 22% to tech. Keeping the example simple, a 20% allocation to IYW would result in a 4.5% portfolio weight in Apple, a 20% weight in XLK would result in a 3.9% weight in Apple and a similar exposure to VGT would put 2.9% of the portfolio in Apple.

In the mutual fund industry a so-called concentrated portfolio has 30 to 40 holdings which implies an average weighting for each stock of 2.5% to 3.3%, so the exposure to Apple available in the sector ETFs is substantial and the performance of the three sector ETFs reflects that fact.

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Year to date, IYW is up 21%, XLK is up 18.5% and VGT is up 20% compared to an 11% gain for the S&P 500. Obviously all three funds have benefitted from the 56% gain in Apple. The reason for the lag in XLK is that this fund actually combines the tech sector and the telecom sector and telco stocks have generally lagged the rally in the broad market this year.

The dominance of one stock exists in a couple of other sectors as well. For example the large energy sector ETFs are heaviest by far in

Exxon Mobil

(XOM) - Get Exxon Mobil Corporation Report

. The

iShares DJ US Energy Sector Index Fund

(IYE) - Get iShares U.S. Energy ETF Report

allocates 25% to XOM, the

Energy Select Sector SPDR

(XLE) - Get Energy Select Sector SPDR Fund Report

has 18% in XOM and the

Vanguard Energy ETF

(VDE) - Get Vanguard Energy ETF Report

has 23% in XOM. This also occurs with


(T) - Get AT&T Inc. Report



(VZ) - Get Verizon Communications Inc. Report

in telecom sector funds.

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Clearly the tech sector ETFs have benefitted from the huge lift in Apple as that stock has become the largest company by market cap in the world by a wide margin. It should also be clear that a reversal of fortune for Apple will then become a drag on the performance of these funds. In the past, becoming the world's largest stock has not been a positive. It ended badly for


(CSCO) - Get Cisco Systems, Inc. Report



(MSFT) - Get Microsoft Corporation Report


General Electric

(GE) - Get General Electric Company Report



(PTR) - Get PetroChina Co. Ltd. Report

although it did not seem to signify any sort of top for Exxon Mobil.

If an investor would build a portfolio of individual stocks, they would do some form of research on each stock. The examples of Apple and Exxon Mobil means that there must also be some stock research even in an all-ETF portfolio.

This contributor reads:

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Pragmatic Capitalist

Mike Shedlock

Barry Ritholtz

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