With the benchmark Nasdaq Composite breaking at another record high on strong first quarter earnings expectations, more investors are looking at ways to gain exposure to the technology segment and tech-heavy Nasdaq-related exchange traded funds.
Tech companies have been among the best performers of the market, with the S&P 500 Information Technology Sector rising 13.8% and the tech-heavy Nasdaq Composite increasing 12.4% year-to-date, compared to the 6.6% gain in the S&P 500.
The technology segment has been a key component of the growth trade, especially with strong earnings numbers coming out, leading the rally in U.S. markets higher.
For instance, Amazon (NasdaqGS: AMZN) shares were almost 4% higher in after hours trading Thursday after the e-commerce giant revealed first-quarter revenue and profit that surpassed analysts’ estimates, driven by sustained growth in both online retail sales and its cloud business.
Investors who are interested in accessing the growth opportunity of the tech segment have looked to diversified investment options like Nasdaq-related ETFs, including the PowerShares QQQ (NasdaqGM: QQQ), which tracks the Nasdaq-100 Index, along with equal-weight equivalents such as the Direxion NASDAQ-100 Equal Weighted Index Shares (NYSEArca: QQQE) and the First Trust NASDAQ-100 Equal Weighted Index Fund (NasdaqGM: QQEW).
QQQ fully replicates the Nasdaq 100 Index, which includes the 100 largest non-financial stocks listed on the Nasdaq by market capitalization. This is a tech-heavy index, so technology companies make up more than half of the portfolio, including big names like Apple (NasdaqGS: AAPL) 11.8%, Microsoft (NasdaqGS: MSFT) 8.2%, Amazon 6.8%, Facebook (NasdaqGS: FB) and Alphabet (NasdaqGS: GOOG) 4.7%.
“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.