Feeling Tech-Heavy? Diversify With These ETFs Amid AI Bubble Concerns

Concerns over a potential AI bubble have been rising on Wall Street, with more investors warning that the sector’s rapid gains may have become overextended.

Investing heavily in the technology sector to capitalize on AI’s growth potential comes with increased concentration and systemic risk, making it necessary for investors to diversify. According to strategists at Citigroup, as quoted on Reuters, roughly half of the S&P 500’s $57 trillion market cap has significant or moderate exposure to AI.

Long-term investors should consider broadening their exposure. This will enable them to preserve their growth potential while reducing vulnerability to market shocks that arise from overconcentration.

Wall Street’s Growing AI Worries

Global Fund Manager Survey by Bank of America, according to Yahoo Finance, flagged an “AI equity bubble” as the top global tail risk for the first time in the survey’s history.

Per the Reuters article, while Barclays strategists are optimistic about AI over the next 12-18 months, they warn that the energy infrastructure may be insufficient to support expanding data centers. Investors are also watching closely for any slowdown in demand or underwhelming returns on massive AI investments.

Lending weight to the increasing warnings, the Bank of England and the IMF warned that global markets may stumble if the AI boom loses momentum, according to CNBC. Per IMF chief Kristalina Georgieva, according to the CNBC article, U.S. tariffs and sky-high stock valuations are other warning signs.

Additionally, adding to the uncertainty, JPMorgan CEO Jamie Dimon emphasized caution, noting that asset valuations remain high and credit spreads continue to be stretched, as quoted in the abovementioned Yahoo Finance article.

With the Dow Jones U.S. Technology Index up about 25.24% over the past year, some strategists believe worries about an AI bubble may be exaggerated. However, certain trends suggest caution.

According to Goldman Sachs, as quoted on Investopedia, big tech’s increased debt issuance this year, with cash reserves declining, points to growing systemic risk. The Dow Jones U.S. Technology Index’s 0.76% decline month to date highlights the warning signs.

ETFs to Consider

The AI momentum will continue to drive market gains, but the risk of concentrated rallies in select names makes the market vulnerable to larger drawdowns, requiring portfolio diversification. Diversification remains one of the most effective strategies for building resilient portfolios.

Reducing concentration risk by diversifying into ETFs that focus on value sectors or equal-weighted strategies can enhance resilience while still capturing upside potential. Adjusting away from overweight exposure to mega-cap tech will seem painful in the short term, but it will help long-term investors lower their portfolio risk while retaining growth potential.

Below, we highlight a few areas in which investors can increase their exposure. These sectors provide dual benefits, protecting portfolios during market downturns and offering gains when the market rises.

Equal-Weighted ETFs

These funds offer sector-level diversification by assigning equal weight to each constituent stock, regardless of market capitalization, reducing concentration risk. This makes them a relevant choice for investors seeking diversified exposure across sectors. The S&P 500 Equal Weight Index has gained 7.59% year to date.

Invesco S&P 500 Equal Weight ETF RSP, ALPS Equal Sector Weight ETF EQL and Invesco S&P 100 Equal Weight ETF EQWL are some good options.

Value ETFs

Characterized by solid fundamentals, such as earnings, dividends, book value and cash flow, these stocks trade below their intrinsic value, representing undervaluation. The S&P 500 Value Index has gained 7.52% year to date.

Vanguard Value ETF VTV, iShares Russell 1000 Value ETF IWD and iShares S&P 500 Value ETF IVE, having a Zacks ETF Rank #1 (Strong Buy) or 2 (Buy), could be appealing options.

Consumer Staple ETFs

Increasing exposure to consumer staple funds can bring balance and stability to investors’ portfolios. Investors can put more money in consumer staples funds to safeguard themselves from potential market downturns. The S&P 500 Consumer Staples Index has gained 3.20% year to date.

Investors can consider Consumer Staples Select Sector SPDR Fund XLP, Vanguard Consumer Staples ETF VDC and iShares U.S. Consumer Staples ETF IYK.

International Equity ETFs

Investors with portfolios concentrated in ETFs tracking major U.S. benchmarks like the S&P 500 are more exposed to the information technology sector than they might realize, particularly to the “Magnificent 7” tech giants. The S&P 500 allocates roughly 35% to information technology.

To balance this tilt, adding international equity ETFs can broaden geographical exposure and strengthen overall diversification. Additionally, investing in international equity ETFs could also potentially boost risk-adjusted returns.

The S&P World Index, which tracks the performance of stocks from 24 developed economies, has risen 14.48% over the past year and 15.79% year to date.

Investors can also consider funds such as Dimensional International Core Equity Market ETF DFAI and Avantis International Equity ETF AVDE.

Those willing to take on slightly more risk can increase their exposure to emerging market ETFs, unlocking the potential for higher returns. Investors can look into funds like iShares Core MSCI Emerging Markets ETF IEMG and Vanguard FTSE Emerging Markets ETF VWO.

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This article originally published on Zacks Investment Research (zacks.com).

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