As has been widely documented, the Nasdaq-100 Index (NDX) is heading toward a special rebalancing on Monday, July 24.
The widely followed benchmark usually rebalances once annually, in December, but special reconfiguration was needed. The magnificent seven of Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), Alphabet (NASDAQ: GOOG), Amazon (NASDAQ: AMZN), Nvidia (NASDAQ: NVDA), Tesla (NASDAQ: TSLA), and Facebook parent Meta Platforms (NASDAQ: META) recently combined to command more than half the benchmark’s weight.
The rebalancing is aimed at reducing the concentration risk of actively managed funds and passive exchange traded funds, namely the Invesco QQQ Trust (QQQ) and the Invesco NASDAQ 100 ETF (QQQM), that benchmark to NDX.
For investors concerned about this event, it’s not a cause to fret. In fact, NDX has been down this road before. In 1998, a special rebalance was needed after Microsoft alone controlled a quarter of the gauge. It happened again in 2011 when Apple commanded 20%, more than five times the allocation of the index’s second-largest component.
Implications for QQQ, QQQM
The history of unusual NDX rebalances is interesting.
“Over the next decade, that decision benefited the benchmark. (Well, almost the next decade, as my data source begins in April 1999.) It lost 40%, but Microsoft fared worse yet, losing 51%. A rough stretch, to be sure, but nonetheless the rebalance was helpful,” noted Morningstar’s John Rekenthaler.
Conversely, NDX and QQQ trailed Apple in the 10 years following the 2011 rebalance. Still, the index turned $10,000 into more than $64,000 over that span. Additionally, experienced ETF investors know that it’s common for an ETF to lag the performance of its best-performing holdings over lengthy periods.
Speaking of lengthy holding periods, as Rekenthaler pointed out, the Nasdaq-100 beat the bulk of large-cap growth funds over the past 24 years when costs are stripped out. That picture gets muddied when accounting for some high-fee active funds that follow the index. This underscores the benefits of QQQM’s annual fee of 0.15%, or $15 on a $10,000 stake. QQQ charges 0.20% per year.
NDX’s “performance illustrates one of his core beliefs: that the critical element of low-cost indexing is the first term, not the second. It is a faulty benchmark, but if it can be acquired on the cheap, it will likely outdo its investment rivals over the next 25 years, as it has done over the past quarter century,” concluded Rekenthaler.
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