ETFs to Play as Investors Chase Diversification Amid Tech Rout

The tech-led market rout deepened on Thursday as U.S. software and data services stocks witnessed continued losses for the seventh straight session, amid fears that rapid AI advances could disrupt the sector.

According to a Reuters article, the S&P 500 software and services index fell 4.6%, wiping out nearly $1 trillion in value since Jan. 28, in a selloff dubbed “software-mageddon,” as it coincided with a broader rotation out of technology and into value-oriented sectors such as consumer staples.

Since Jan. 28, the Nasdaq Composite has fallen about 5.6%, while the broader S&P 500 has declined roughly 2.6% over the same period. Over that time, market volatility has also surged, with the CBOE Volatility Index up about 24% since Jan. 28 and nearly 40% since the start of the year, underscoring the heightened uncertainty investors are navigating.

Growing risk aversion is pushing investors to reduce exposure to U.S. technology stocks and diversify more broadly beyond U.S. assets, which is becoming increasingly evident in global fund flows. According to LSEG Lipper data, as quoted on another Reuters article, as concerns grow around lofty U.S. tech valuations, investors are directing fresh inflows toward global ex-U.S. equity funds. January saw global ex-U.S. equity funds, including ETFs, draw $15.4 billion in inflows, the most in over four years, amid pressure on global technology stocks from rising AI investment costs and a recent selloff linked to Anthropic’s Claude launch.

Big AI Bets, Bigger Investor Doubts

Wall Street is increasingly scrutinizing Big Tech’s massive AI investments for tangible returns. Concerns over elevated AI-related capital spending have weighed on tech stocks, with several giants seeing their shares slide after earnings reports highlighted further capex expansion.

According to Reuters, tech giants, including Amazon, Microsoft, Google and Meta, are on track to spend more than $630 billion combined this year, underscoring the scale of Big Tech’s AI investment push. Amazon’s latest earnings reinforced this trend, with the company signaling plans to invest around $200 billion in AI initiatives in 2026 as it accelerates its AI infrastructure buildout.

Per the abovementioned Reuters article, the outlook sent Amazon shares down 11.5% in after-hours trading, intensifying investor concerns over the rising costs of the artificial intelligence boom. This reaction mirrors the market’s unfavorable response to Alphabet’s higher projected capital expenditures for 2026.

Diversification and Capital Preservation With ETFs

Diversification remains one of the most effective strategies for building resilient portfolios, especially in a market driven by a few dominant players. Reducing concentration risk by allocating to ETFs focused on stable cash flows and resilient sectors can strengthen portfolio durability while still allowing investors to participate in broader economic upside.

These sectors offer a dual advantage, helping shield portfolios during periods of market stress while providing upside potential when market conditions improve. For long-term investors, broadening exposure is key to preserving growth prospects and reducing vulnerability to shocks stemming from excessive concentration.

Preserving capital and cushioning volatility are key for investors looking to navigate a potentially tumultuous period. As gold and silver face growing uncertainty and sharp price swings, investors may want to diversify their safe-haven exposure beyond precious metals.

Increasing allocations to alternative defensive ETFs can provide a more predictable approach to preserving capital while maintaining market participation. Below, we have highlighted several areas where investors can consider expanding their exposure.

Consumer Staple ETFs

Increasing exposure to consumer staple funds can bring balance and stability to investors’ portfolios. Investors can allocate more money to consumer staple funds to safeguard themselves against potential market downturns.

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

Utility ETFs

As a low-beta sector, utilities are relatively shielded from market volatility, making them a defensive investment and a safe haven during economic turmoil. Investors often turn to utilities during downturns due to the steady demand for these companies' services.

Investors should gain from funds like Utilities Select Sector SPDR Fund XLU, Vanguard Utilities ETF VPU and iShares U.S. Utilities ETF IDU.

Healthcare ETFs

The healthcare sector is non-cyclical, providing a defensive tilt to the portfolio amid market turmoil. Further, the long-term fundamentals remain strong, given encouraging industry trends.

Investors can look at funds like Health Care Select Sector SPDR Fund XLV, Vanguard Health Care ETF VHT and iShares U.S. Healthcare ETF IYH.

Global Exposure for Smarter Diversification

Portfolios heavily invested in ETFs tracking broad U.S. market benchmarks such as the S&P 500 are often more concentrated than they appear, with significant exposure to the information technology sector, particularly in the “Magnificent 7” tech leaders. 

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

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

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

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