ETFs to Track the Changing Faces of Innovation Over Time | ETF Trends

As we explore the world of innovation, there are some key considerations for exchange traded fund investors when researching the space and ways to effectively invest.

In the recent webcast, Beyond Tech: How Innovation is Changing the World, Ryan McCormack, factor & core equity strategist at Invesco, and Mark Marex, research & development specialist at Nasdaq Global Indexes, highlighted the Nasdaq-100 as a benchmark for innovation throughout the years, helping investors track disruptors, game-changers, forward-thinkers, or companies that influence our lives daily in multiple areas. At the turn of the 20th century, these companies included GE, Chicago Gas Company, American Sugar Company, and others that accelerated growth. Today, companies like Apple, Amazon, Google, Facebook, and Microsoft have become global leaders in the technology sector by creating products and services that are essential to both individual consumers and enterprise customers.

This focus on innovative growth has helped the Nasdaq-100 Index outperform. The Nasdaq-100 has outperformed the S&P 500 in 11 of the past 12 years, including by more than 30% in 2020. Since 2007, the cumulative total returns were 711% for NDX, more than double the returns of 290% for SPX.

Looking at the Nasdaq-100 compared to the S&P 500, over 11 of the last 12years, the average market cap has been higher in NDX than SPX. The median market cap has been higher for NDX than SPX in each of the last eight years as well. The market cap of NDX tends to be truer to large-cap than SPX — the smallest company in NDX ($17.3 billion) has been larger than the smallest company in SPX ($3.1 billion) for the last 12 years.

The Nasdaq-100 has also been quicker on the uptake for innovative up-and-comers. For example, Tesla was added to the S&P 500 in December 2020, the largest addition in the index’s history, but this happened approximately 7.5 years after it was added to the Nasdaq-100. Tesla’s price has advanced about 2,500% in that period.

To better understand the notion of innovation, investors can look to a company’s research and development, as R&D is a key driver of innovation and economic growth. Companies in the Nasdaq-100 spend nearly twice as much in R&D, on average, compared to those in the S&P 500. Calculating R&D as a percent of sales in the last 12 months, Nasdaq-100 companies averaged 40% higher than S&P 500 components. The current crop of Nasdaq-100 constituents has grown the value of their patents by around 900% since May 2007, compared to about 300% across all publicly-listed, tracked companies globally. Growth for the S&P 500 overall was 450%, but only 331% excluding the contribution of overlapping Nasdaq-100 firms. To put this in perspective, global growth of ex-U.S. companies was only 268%.

Disruptive technologies remain a key theme among Nasdaq-100 constituents. 58 companies in the Nasdaq-100, representing 81% of index weight, recently filed patents across one or more of 35 key areas of disruptive technology such as artificial intelligence, clean energy, and blockchain, among others.

The strategists argued that the underlying story for the rise in the Nasdaq-100 is that the U.S.’s economic growth is shifting from capital-intensive, traditional industries like basic materials and oil & gas to the “new-economy” sectors such as technology and consumer services.

Furthermore, the strategists pointed out that the fundamental data behind the Nasdaq-100 has drastically improved over the past decade despite a volatile economy and the greatest financial market collapse since the Great Depression. Specifically, earnings, the most basic number to value a company, have skyrocketed, showing maturation of the companies as they increase revenues but reduce costs. Costs have been controlled, shares have been bought back, dividends have increased, and P/E has contracted. The shift in NDX fundamentals has resulted in significant outperformance over other U.S. large-cap indexes.

Investors can look to the Nasdaq Next Generation 100 Index, which acts as the underlying index for the Invesco NASDAQ Next Gen 100 ETF (QQQJ), to target the next growth opportunities.

Since 2010, a total of 64 constituents have “graduated” from the Nasdaq Next Generation 100 Index into the Nasdaq-100. Some well-known examples include Netflix in 2010, Tesla Motors in 2013, and Moderna in 2020. As of December 31, 2020, 34 of the current 100 companies in the Nasdaq-100 had graduated from the Nasdaq Next Generation 100 Index at some point over the past decade.

The Nasdaq Next Generation 100 Index also follows a modified weighting methodology. Consequently, the Nasdaq Next Generation 100 Index tilts much smaller than the Nasdaq-100, but still meaningfully above the S&P Midcap 400 and fairly close to the Russell Mid Cap Growth. The Nasdaq Next Generation 100 Index is most overweight in technology and healthcare relative to the S&P Midcap 400 and most overweight in consumer services relative to both mid-cap benchmarks.

Compared to similar mid-cap benchmarks from S&P and Russell, Nasdaq Next Generation 100 constituents have grown their dividends and R&D expenditures at a higher rate over the past decade.

Invesco recently partnered up with Nasdaq to expand its Invesco QQQ Innovation Suite with the introduction of two new environmental, social, and governance (ESG) ETF offerings: the Invesco ESG NASDAQ 100 ETF (QQMG) and the Invesco ESG NASDAQ Next Gen 100 ETF (QQJG). The two new offerings advance the firm’s goal of providing investors the benefit of personalizing their exposure to the innovative companies listed on the Nasdaq Stock Market.

Through the launch of QQMG and QQJG, which track the performance of the Nasdaq-100 ESG Index® and the Nasdaq Next Generation 100 ESG Index™, respectively, Invesco expands this exposure to ESG by giving investors the option to access the same companies as QQQM and QQQJ, but with a tilt towards ESG-related values.

While the original composition of both the Nasdaq-100 Index and the Nasdaq Next Generation 100 Index was already predisposed to companies favorable to ESG, the Nasdaq-100 ESG Index and Nasdaq Next Generation 100 ESG Index both include additional layers of ESG analysis. In constructing these ESG indexes, Nasdaq filters constituent companies through a robust set of ESG criteria utilizing Sustainalytics’ market-leading ESG data.

Financial advisors who are interested in learning more about innovative strategies can watch the webcast here on demand.