XLP ETF: Overconcentration, Stagnant Growth, and the Case for Alternatives in Consumer Staples

The Consumer Staples Select Sector SPDR® Fund (XLP) has long been a go-to investment for exposure to the U.S. consumer staples sector. However, its recent portfolio composition and performance metrics raise red flags about overconcentration in megacap stocks, slowing sector growth, and elevated valuations. For investors seeking resilience without overexposure, it's time to critically assess whether XLP still fits their strategy—or if alternatives are now more compelling.

Overconcentration in Megacaps: A Double-Edged Sword

The XLP ETF's top holdings reveal a stark concentration in just a handful of companies. As of June 12, 2025, Costco (COST), Walmart (WMT), and Procter & Gamble (PG) alone account for 28.6% of the fund's assets, while the top five holdings make up 31.6% of the portfolio. This heavy reliance on a few megacaps creates vulnerability.

Consider this: If one of these giants faces a headwind—such as supply chain disruptions, regulatory scrutiny, or declining consumer demand—the entire fund could suffer disproportionately. For instance, Walmart's recent struggles with e-commerce competition and Coca-Cola's (KO) stagnant beverage sales highlight risks that are magnified in a concentrated portfolio.

The fund's weighted average market cap of $224 billion further underscores its megacap bias, leaving little exposure to smaller, more agile companies that might thrive in a shifting market.

Slowing Sector Growth: The Elephant in the Room

While consumer staples are often viewed as a “defensive” sector, their growth is now stalling. The XLP's 1-year return of 9.98% as of May 2025 lags its historical performance, and its 1-month return of just 1.22% signals stagnation. Key sub-sectors like beverages and household products, which make up nearly 37% of XLP's portfolio, face structural challenges:

1. Beverages: Declining soda consumption and rising competition from health-focused alternatives (e.g., sparkling water, plant-based drinks) are squeezing giants like Coca-Cola and PepsiCo (PEP).
2. Household Products: Procter & Gamble and Colgate-Palmolive (CL) are grappling with margin pressures due to inflation and shifting consumer preferences toward private-label brands.
3. Tobacco: Even Philip Morris (PM) and Altria (MO), which dominate the fund's 11% tobacco allocation, face headwinds from declining smoking rates and regulatory pressures.

The sector's estimated 5.45% 3-5 year EPS growth reflects this slowdown, making XLP's high valuation harder to justify.

Valuation Concerns: Are Investors Overpaying?

With the XLP trading at a P/E ratio of 20.46x, its valuation is now 20% higher than its 10-year average. This premium assumes flawless execution from megacaps like Walmart and Costco, which are already stretched in a cost-sensitive economy.

Compare this to the broader S&P 500, which trades at a P/E of ~18x. The disconnect suggests investors are overestimating the resilience of consumer staples megacaps in a high-interest-rate environment.

Alternatives for a More Resilient Portfolio

For investors seeking consumer staples exposure without overconcentration, consider these alternatives:

1. Consumer Staples ETFs with Smaller-Cap Exposure:
2. The iShares U.S. Consumer Staples ETF (IYZ) holds a broader mix of mid- and large-cap stocks, reducing reliance on a few giants.

3. The Global X Superfood ETF (SLFG) targets niche growth areas like plant-based foods and wellness products, which are outperforming traditional staples.

4. Dividend-Focused ETFs with Diversification:

5. The Vanguard Consumer Staples ETF (VDC) offers lower fees (0.10%) and slightly more diversification than XLP.

6. The First Trust Consumer Staples AlphaDEX Fund (FXN) uses a “high-minus-low” strategy to favor companies with strong fundamentals, avoiding overvalued megacaps.

7. International Exposure:

8. The iShares MSCI Global Consumer Staples ETF (KXI) provides access to international firms like Nestlé and Unilever, which may offer better growth prospects than U.S. stalwarts.

Investment Takeaways

The XLP ETF's overconcentration in a handful of megacap stocks, coupled with slowing sector growth and elevated valuations, makes it a high-risk choice for defensive investors. While its low expense ratio (0.08%) and liquidity are positives, they're outweighed by structural risks.

Actionable advice:
- Reduce exposure to XLP if it represents a large slice of your portfolio.
- Diversify into smaller-cap or international staples ETFs to mitigate concentration risk.
- Monitor top holdings like COST, WMT, and PG for signs of weakness or regulatory headwinds.

In a market where resilience demands flexibility, sticking with XLP's megacap-heavy strategy may no longer be the safest bet.