The rebalance of the S&P 500 and Nasdaq-100 on Friday may indicate worries about concentration risk.

In 2023, a small group of large technology companies have a significant presence in major stock indexes such as the S&P 500 and the Nasdaq-100.

Six companies (Apple, Microsoft, Amazon, Nvidia, Alphabet and ) account for approximately 40% of the Nasdaq-100, while five companies (, , , and ) comprise roughly 25% of the S&P 500.

This Friday, the S&P 500 and Nasdaq are rebalancing their indexes. While this is a regular occurrence, some of the changes may reflect the focus on managing concentration risk.

A ton of money is pegged to a few indexes

The last major "liquidity events" of the year are the rebalances, which coincide with the quarterly expiration of stock options, index options, and index futures, known as triple witching.

The trading community can take advantage of the last gasps of tax loss harvesting or position for the new year by trading large blocks of stock during the final two weeks of the year, when trading volume typically drops 30%-40%. Only the final trading day will show significant volume.

The big move to passive index investing in the past 20 years has made these events more significant to investors.

The adjustment of indexes, whether due to additions, deletions, or changes in share counts or weightings, results in significant inflows and outflows of funds from mutual funds and ETFs that are linked to the indexes.

Nearly $13 trillion is directly or indirectly linked to the S&P 500, with the three largest ETFs, namely , , and , all being directly indexed to the S&P 500 and managing nearly $1.2 trillion in assets.

The QQQ ETF, which tracks the Nasdaq-100 index, is the fifth-largest ETF with approximately $220 billion in assets under management.

Apple and others will be listed on the S&P 500, with Uber joining the index.

Standard & Poor's will adjust the weighting of each stock in the S&P 500 to account for changes in share count resulting from buyback programs.

In this quarter, Apple, Alphabet, Microsoft, Amazon, and Facebook will experience a reduction in their share counts, causing funds indexed to the S&P to adjust their weighting accordingly.

S&P 500: Companies with share count reduction

(% of share count reduction)

• Apple        0.5%
• Alphabet   1.3%
• Comcast    2.4%
• Exxon Mobil  1.0%
• Visa                0.8%
• Marathon Petroleum  2.6%

Source: S&P Global

The share counts of other companies, including Amazon, will increase, causing funds indexed to the S&P 500 to increase their weighting.

Last week, I wrote about the impact of being added to the S&P 500 on Uber's stock price.

Three other companies will be removed from the S&P 500 index and moved to the S&P SmallCap 600 index: , and .

Nasdaq-100 changes: DoorDash, MongoDB, Splunk are in

The Nasdaq-100 undergoes a reconstitution process annually in December, but is rebalanced four times a year.

On Friday, Nasdaq declared that six companies would be included in the Nasdaq-100 index: CDW, Coca-Cola Europacific Partners (CCEP), DASH, MDB, ROP, and SPLK.

Six others will be deleted: (ALGN), (EBAY), (ENPH), (JD), (LCID), and (ZM).

On Tuesday night, Nasdaq announced that Seagen would be removed from the Nasdaq-100, while also adding to the index following its pending acquisition.

Concentration risk: The rules

Under federal law, diversified investment funds, such as mutual funds and exchange-traded funds, must adhere to certain diversification requirements. These requirements include limiting the percentage of assets held in a single issuer to 25% and ensuring that securities representing more than 5% of the total assets do not exceed 50% of the total portfolio.

Most of the major indexes have similar requirements in their rules.

The S&P sector indexes, which serve as the basis for many widely traded ETFs such as XLK, follow similar diversification rules to those discussed above. For instance, no single stock can account for more than 24% of the float-adjusted market capitalization of that sector index, and the combined weight of companies with weights greater than 4.8% cannot exceed 50% of the total index weight.

If the prices of Microsoft, Apple, and Broadcom remain the same at the close on Friday, the combined market weight of these three companies in the Technology Select Sector will decrease slightly.

After the close on Friday, the S&P will reveal any updates regarding the sector indexes.

The Nasdaq-100 employs a "modified" market-capitalization weighting system, which restricts the size of the weighting for any individual stock to mitigate overconcentration risk. As a result, rebalancing may decrease the weighting of some of the largest stocks, such as Apple, Microsoft, Amazon, Nvidia, and Alphabet.

In the first half of the year, the rapid move up in large tech stocks led Nasdaq to take an unusual step of initiating a special rebalance in the Nasdaq-100 to address the overconcentration of the biggest names. As a result, Microsoft, Apple, Nvidia, Amazon, and all saw their weightings reduced.

Market concentration is nothing new

The question of whether market concentration rules should be tightened is a topic of ongoing debate, with discussions surrounding the issue for many years.

The five largest companies in the S&P 500 accounted for approximately 25% of the index's weight in the 1970s, according to Phil Mackintosh and Robert Jankiewicz from Nasdaq.

Disclosure: Comcast is the corporate parent of NBCUniversal and CNBC.

The Nasdaq-100 index has been updated with the inclusion of Take-Two Interactive and the exclusion of Seagen.