Natixis has partnered with Nasdaq Inc. to craft a new index that tries to address the market-capitalization bias found in traditional indices, potentially paving the way for a smart beta exchange traded fund diversifier for Nasdaq-100 investors.
“Natixis is delighted to partner with Nasdaq in creating a pricing-friendly, rules-based index linked to the Nasdaq-100 universe for structured notes investors,” Dennis Shikar, Head of Equity Markets Americas at Natixis, said in a note. “This partnership illustrates our commitment to providing smart and unique equity solutions that will expand our offerings to both our distributors and institutional clients.”
The news was announced at the NASDAQ exchange Monday where Natixis rang the opening bell.
The newly created Nasdaq-100 Target 25 Index will select 25 of the 100 companies included in the benchmark NASDAQ-100 Index that have smaller market capitalization, which have the highest free cash flow yields and are then equally weighted. The smart beta index will then replicate the performance of the total return version where dividends are reinvested and discounts a fixed dividend of 2.5% in order to calculate the excess return.
The Nasdaq-100 has been one of the most popular passive investment strategies, tracking the 100 largest non-financial companies listed on the Nasdaq Stock Market and is weighed by market capitalization. However, critics have argued that the over concentration of an index’s top positions in a market cap-weighted methodology may leave investors open to potential risks. For instance, the top five stocks in the Nasdaq-100 include Apple (NasdaqGS: AAPL), Alphabet (NasdaqGS: GOOGL), Microsoft (NasdaqGS: MSFT), Amazon (NasdaqGS: AMZN) and Facebook (NasdaqGS: FB), which make up over 40% of the Nasdaq-100 Index.
However, the new indexing methodology could help investors outperform the benchmark. Looking at back-tests, an equally weighted bottom 50 portfolio has outperformed the top 50 portfolio since 2001.
“The Nasdaq-100 Target 25 Index is a new, ‘smart‘ Nasdaq-100 Index that targets the under-valued bottom half of the Nasdaq-100. Our research shows that Free Cash Flow Yield (FCFE to Price) is one of the most effective factors to rank these stocks. Our equally weighted, Top 25 Free Cash Flow Yield stock portfolio provides excellent diversification and strong selection of securities from one of the best performing flagship indexes of the last decade, the Nasdaq-100 Index,” according to a Nasdaq research note.
For more information on ETF index methodologies, visit our indexing category.