On July 24, the Nasdaq-100 Index, also known as the NDX, implemented a “Special Rebalance” for only the second time in 25 years. The aim of this rebalance was to reduce the influence of a few key stocks, which had grown to have a large effect on the index.
Key Changes for the Nasdaq-100 Special Rebalance
- The weight of the seven largest stocks in the index will be reduced by 12 percentage points (56% to 44%).
- NVDA and MSFT were the most affected stocks, with the weight of each declining by about 3 percentage points.
- AAPL weight fell to 11.5% (from 12.1%) but it became the largest constituent; MSFT ranked second with a 9.8% weight (from 12.8%).
- AVGO’s index weight increased the most from 2.4% to 3.0%.
- The Technology sector weight decreased from 51% to 49%; all other sector weights were impacted by less than 2 percentage points.
What is the construction methodology behind the index?
The Nasdaq-100 is a market-cap weighted index that includes the 100 largest non-financial companies by market cap listed on Nasdaq. It was designed this way in December 1998 to meet certain IRS Regulated Investment Company diversification rules and to make it easier to use the NDX as a benchmark. Three months after the index construction was adopted, the QQQ ETF, which tracks the Nasdaq-100, was launched. The QQQ ETF has AUM of about $211 billion.
Why did it need a special rebalance?
Nasdaq-100 quarterly rebalances are designed to prevent any issuers from individually carrying an index weight greater than 24%. The rebalances are also intended to prevent issuers with individual index weights greater than 4.5% from collectively accounting for more than 48% of the index. Neither of these conditions were violated at the June quarterly rebalance. With a 12.8% weight, the largest NDX constituent (MSFT) remained well below the 24% limit for individual issuers. However, as of July 3, the six largest issuers each had an index weight greater than 4.5% and collectively accounted for 51% of the index. On July 7, Nasdaq announced the special rebalance, although by then the stocks’ weights had retreated below the 48% threshold.
Did the rebalance affect stock prices or force selling?
At the stock level, passive investment products tied to the NDX adjusted their portfolios automatically. There were signs that investors started trading based on these changes on July 10, the first day after the rebalance announcement. However, based on the only other special rebalance in 2011, the impact on the affected stocks is likely to be minimal. For example, in 2011, AAPL’s influence was cut from 20% to 12%, but this did not have a clear negative effect on the stock’s performance.
So, what does this mean for investment strategies?
The NDX special rebalance doesn’t fix the problem of market concentration for many large cap growth investors using the NDX, or the Russell 1000 Growth Index for that matter. According to the Investment Company Act of 1940, a “diversified” fund cannot have more than 25% of its portfolio in positions that each account for more than 5% of its portfolio. This has led to many large cap growth managers underweighting the largest stocks, which has created headwinds for large cap growth funds’ performance relative to their benchmarks.
Only $10 billion of active mutual fund AUM is benchmarked to the NDX, compared with $805 billion for the Russell 1000 Growth and $2 trillion for the S&P 500. But according to EPFR, which tracks fund flows, $261 billion in mutual fund and ETF assets under management is benchmarked to the NDX, while hedge funds have an estimated $20 billion of net short exposure.
Even after the rebalance, the NDX will still be too concentrated to be considered a “diversified” fund by the SEC, as stocks with more than 5% weight will make up 32% of the index.
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