“Most of its holdings generate attractive returns on invested capital and enjoy durable competitive advantages,” Alex Bryan, Director of Passive Strategies Research at Morningstar, said in a note.
However, investors should be aware of potential risks of market cap-weighting methodologies, namely their tilt toward high performers and the risk of a potential pullback.
“This weighting approach increases the fund’s exposure to stocks as they become larger and more expensive and reduces its exposure to stocks as they become smaller and cheaper, which may have higher expected returns,” Bryan said. “It also allows the market to dictate the composition of the portfolio and can increase concentration.”
Alternatively, investors can take a look at the equal-weight indexing method, which helps emphasize more undervalued stocks since market-cap-weighted methodologies typically overweight larger components that have been outperforming. In contrast, the equal-weighting methodology would rebalance on a regular basis, selling recent winners and buying recent losers to maintain its equal tilt.
Both QQQE and QQEW would only have about a 1.0% tilt toward each of its components. Consequently, QQQE and QQEW may have a larger mid-cap tilt compared to QQQ. The broader diversification may help reduce concentration risk, but potential investors should be aware that due to the equal-weight methodology, these two ETFs would include slightly lower tilts toward the tech segment and lean more toward healthcare and consumer staples.
Full disclosure: Tom Lydon’s clients own shares of QQEW.