3 Reasons Why Investing in the Nasdaq-100 Is Effective
This article was first published in Zuu online on July 8, 2022. Click here for the original article in Japanese.
Index (stock price index) investment” is used by many investors as a typical means of long-term asset management. Index investing does have a drawback; you cannot always expect large profits because the price movements of indices are more stable than those of individual stocks. This report focuses on the “Nasdaq-100,” an index that we can expect to perform better than any other index. We will discuss three reasons why it is worthy of an investor’s attention, with detailed explanations.
Five Strengths and Weaknesses of Index Investing
When one hears that stocks are going up, so you might as well start doing some ‘asset management’ yourself, the first question that you confront is what should you buy?
Although there are many investment information websites you can easily look at, it is difficult to determine which site provides the most appropriate information. People say that it is best to buy from companies that are close to your life and work but investing in individual stocks naturally carry the risk of large price declines.
What about mutual funds recommended on websites for novice investors? Unlike individual stocks, mutual funds are based on “diversified investment,” where investors invest in multiple stocks and financial instruments in accordance with the theme and objectives of the mutual fund, so the risk of price fluctuation is relatively small. However, you have to decide which mutual fund is right for you. The number of mutual funds is limited, and the risk of price fluctuation increases if you try to earn a certain level of return from them. In the end, if you cannot decide on “the one,” you can buy an investment trust that many people have already purchased. For mutual fund investment, there are also management fees to consider.
As discussed in this scenario, while individual stocks have the potential for large price increases, they also have the risk of large price decreases. In addition, in order to diversify your investment across multiple stocks, you will need a certain amount of money. In the beginning, it is safe to buy mutual funds or exchange-traded funds (ETFs) that are linked to stock price indexes, which are called “index investments.”
However, index investments have a certain “weakness” in that their performance is slower than that of individual stocks. You cannot really expect high performance, such as multiple increases in the price of an index over a short period of time.
Of course, this weakness can be turned into a strength in that the risk of a price decline is smaller than that of individual stocks and price movements are more stable. However, when starting an investment, a gain of a few percent per year may not be satisfactory.
Even though we understand that long-term investment is the premise of asset management and that it is too early to come to a solid conclusion after one or two years, we would like to see our assets increase at least a little more.
Three Major U.S. Stock Indices
In index investing, stock price indices related to the U.S. market are now attracting increasing attention. While the Nikkei Stock Average and other Japanese indices have yet to reach new highs, the U.S. indices have been rising strongly and reaching new highs.
The new highs in the U.S. market indices represent positive earnings at this point in time, regardless of when they were purchased in the past. Furthermore, because the U.S. population is expected to continue to grow, and as many companies that drive the global economy are listed on the U.S. market, there is growing interest in investing in U.S. stocks.
The U.S. stock market has three representative stock price indexes: The first is the Dow Jones Industrial Average, or the so-called “New York Dow Jones Index” (NY Dow). It is composed of 30 representative U.S. stocks listed on the New York Stock Exchange and Nasdaq. Traditionally, the NY Dow has been composed of well-known old-economy companies, but in recent years, IT and high-tech companies have also been added to the component stocks due to the rapid progress of high-tech companies.
The second index that is widely known is the S&P 500 Index. While the NY Dow is composed of 30 stocks, the S&P 500, as its number indicates, is composed of 500 stocks. Therefore, it is said to be the best index to understand the overall trends of the U.S. market. If you want to invest in U.S. stocks as a whole, it would be appropriate to purchase mutual funds or ETFs that are linked to the S&P 500 rather than the NY Dow.
The third index, the NASDAQ Composite Index, is perhaps the most familiar to the younger generation. The index consists of approximately 3,739 stocks listed on the NASDAQ market (as of June 30, 2022; source: Nasdaq), mostly high-tech and IT companies and startups, and is calculated by weighting the market capitalization of each stock.
The younger generation tends to be more familiar with this index because many IT companies are listed on the NASDAQ market, such as Apple, which has introduced the iPhone, Google (officially known as Alphabet), and Amazon, which provides products and services that are now indispensable to people’s daily lives. The market capitalization of these companies is larger than that of the entire Tokyo Stock Exchange. The index’s total market capitalization is much larger than that of the entire Tokyo Stock Exchange, making it the world’s second-largest market after the New York Stock Exchange.
Reason #1 for investing in the “Nasdaq-100”: Many companies have grown rapidly amid the COVID-19 pandemic
If you tell someone who is investment-savvy that you don’t want to lose too much money, but you want a reasonable return,” they could see it as a rather greedy wish. However, there is one index that could potentially make that wish come true. It is the Nasdaq-100 Index (Nasdaq-100), an index related to the Nasdaq market in the United States, which is composed of 100 stocks listed on the Nasdaq market.
It was established in 1985, about 14 years after the Nasdaq Composite Index was first calculated in February 1971. Basically, it is composed of the top stocks in the NASDAQ market by market capitalization, but financial companies are not included.
The Nasdaq-100 has become a mainstay of the U.S. market as a result of the rapid growth of its constituent stocks during the IT bubble that began in the 1990s and the technology bubble that followed. The index is a manifestation of themes such as globalization, digitalization, high technology, and innovation, all of which have become commonplace in the business world in recent years.
In addition to Apple, Google and Amazon, the Nasdaq-100 constituents include Meta Platforms (formerly Facebook); Tesla, the world’s largest manufacturer of electric vehicles; Netflix, the largest video streaming service; PayPal, a payment and remittance service used by more than 300 million people worldwide; Zoom, whose use has rapidly expanded in Japan after the COVID-19 pandemic; and Moderna, which quickly rose to the top of the bio-venture industry with the development of a vaccine for the new coronavirus. These are just a few of the companies that have strengthened their presence in Japan in the wake of COVID-19.
YouTube, which has met people’s needs to get out and about to some extent even during their “stay-at-home” lives, is a Google-owned company. Other high-brand companies such as NVIDIA, the leading manufacturer of graphics boards that display the graphics in computer games; Broadcom, a world leader in semiconductors; and Starbucks are all included in the Nasdaq-100. In short, the Nasdaq-100 covers almost all innovative and progressive companies that are well-known around the world.
Last year, additions to the Nasdaq 100 included Airbnb, an accommodation services provider; CloudStrike, a cloud technology provider; and Honeywell International, a company involved in a wide range of industries, including aircraft, chemicals, and healthcare. The cyclical structure of the Nasdaq 100, where old blood is removed, and new blood is brought in, is one of the attractions of this market.
Reason #2 for investing in the “Nasdaq-100”: Its constituent stocks dominate the global brand power rankings
The most attractive feature of investing in mutual funds and ETFs benchmarked to the Nasdaq-100 is being able to buy the world’s most innovative top-brand companies at the same time. The key themes of AI, big data, cloud services and robotics make up the main businesses of the companies in the index, but it also encompasses biotech, fintech and the media, all of which have shown remarkable growth potential in recent years.
In the ‘Best Global Brands 2021’ list released by Interbrand, a brand consulting firm, Apple ranked first for the ninth consecutive year, followed by Amazon in second place, Microsoft in third, and Google (Alphabet) in fourth, all of which are Nasdaq 100 companies.
The “Five Fastest Growing Brands” also included Tesla, Adobe, PayPal and Microsoft (the remaining one being Salesforce.com in the US). Incidentally, in the “Best Global Brands 2021” list, Samsung of South Korea was ranked fifth and Toyota Motor Corporation seventh as the top Japanese company.
In addition, in Tenet Partners’ ‘Top 100 Most Powerful Brands of 2020’, several Nasdaq-100 companies were included in the top 10, namely Apple, PepsiCo, Alphabet, Microsoft and Amazon. As a Japanese person myself, I am disappointed to see so few Japanese companies on the list, but the bottom line is that many companies which have strong brands and high growth potential are incorporated in the Nasdaq-100.
Another point to note is that many of the companies currently included in the Nasdaq-100 are involved in some kind of global, economic and social change. IT and high-tech conglomerates such as Apple, Cisco Systems and Google have had a huge impact not only on consumers but on companies around the world. And in the retail sector - the sector most familiar to us consumers - companies such as Amazon, PayPal and Starbucks are providing the world with new technological innovations.
As the epicenter of this technological innovation in the world’s industries and economies, the names that make up the Nasdaq-100 are likely to continue to play a leading role in the world five or ten years from now and even beyond.
Reason #3 for investing in the “Nasdaq-100”: High growth rates and undervalued stock price indexes
The Nasdaq 100 is an index “composed of the leading companies of our time,” which is evident in its stock market performance. Cumulatively, over the past 14 years, it has outperformed the S&P 500 by a wide margin. Even in 2020, the Nasdaq 100 outperformed the S&P 500 by more than 30%; its cumulative performance through the end of December 2021 was 803%, more than double the S&P 500’s 333% return.
Cumulative performance comparison of the Nasdaq-100 and S&P 500 over the past 14 years
It is also important to note that the cumulative total returns from 2007 through December 31, 2021, were 803% for NDX, more than double the returns of 333% for the SPX (source: Nasdaq, as of December 31, 2021).
This figure is no coincidence and is backed by the growth of the constituent companies of the Nasdaq-100: since 2003, after the burst of the IT bubble, the average annual growth rate of the constituent companies has been +21% in terms of sales, +13% in terms of earnings, and +26% in terms of dividends, maintaining double-digit growth. Meanwhile, the PER (* price-to-earnings ratio) has fallen to -9%. If we apply this to one company, we see that earnings and dividends are growing at a double-digit pace each year, but the PER is falling.
The PER is calculated by dividing a company’s earnings per share by the share price and is one of the most basic and important stock price indices in stock investment. A lower PER indicates that the stock is less expensive than it was previously.
In the case of the Nasdaq 100, the PER has fallen due to the growth in earnings of its component stocks, which may help explain why investing in the Nasdaq-100 is attractive.
As of April 18, the PER for the Nasdaq 100 as a whole was in the low 30x range, slightly higher than the low 20x range for the S&P 500, but at its peak 20 years ago, the PER was around 250x. Considering this, it is fair to say that the current Nasdaq 100 is not at all overvalued from an index standpoint.
Since the IT bubble of the 1990s and 2000, the Nasdaq-100 has become one of the most popular benchmarks, favored by investors around the world as an aggregate index of outstanding U.S. growth companies.
There are hundreds of related products in addition to mutual funds and ETFs
The Nasdaq-100 is one of the leading stock indices in the U.S. and is already incorporated into a variety of investment products. In Japan, it is possible to invest in the Nasdaq-100 through mutual funds and ETFs (investment trusts listed on the stock market) that are linked to the Nasdaq-100. The following table is an example of Nasdaq-100-related financial instruments that can be purchased in Japan.
Mutual funds and ETFs linked to the Nasdaq-100
The most representative method of investing in the Nasdaq-100 Index in Japan is through mutual funds, such as the eMAXIS NASDAQ100 Index and iFreeNEXT NASDAQ100 Index, which aim to be linked to the index.
With the exception of the SOMPO Switch NASDAQ100 Leveraged 2.5x, which is a leveraged product, there are no significant differences in basic returns and risks regardless of which mutual fund investment trust you purchase, but you should check the trust’s fees, which are holding costs, and the creditworthiness of the management and sales companies.
Alternatively, ETFs are financial instruments that can be bought and sold in the same way as individual stocks. The ordering method and trading commissions are similar to those of stocks, making it an easy way for those who already trade stocks to start investing in the Nasdaq-100. Unlike mutual funds, ETFs do not incur annual trust fees (fund management expenses), making them more suitable for long-term holdings.
A general rule of thumb when investing in ETFs is to choose those which have high daily liquidity (volume). This is because if the daily trading volume is low, sometimes you cannot buy when you want to buy or sell when you want to sell. As for ETFs linked to the Nasdaq-100, there are currently no stocks that have an extremely low daily liquidity, but you should still choose products with a stable daily trading volume.
“Currency Hedged” and “Leveraged”
As shown in the table above, many ETF managers offer two types of ETFs: “currency hedged” and “without currency hedging” The difference between the two is that “no currency hedged” is designed so that even if the exchange rate (in this case, dollar/yen) moves against the yen, there is almost no impact on income and expenses, whereas “no currency hedged” is designed so that a currency exchange rate (in this case, the dollar-yen exchange rate) moves against the yen (in this case, the dollar-yen exchange rate) with little or no impact on income or loss.
Given the current awareness of the interest rate differential between the U.S. and Japan and the yen’s tendency to depreciate against the dollar, the return obtained by selecting the “no currency hedge” option may be greater.
However, there are those who may consider the long-term prospects of the Nasdaq-100 to be the main purpose of purchasing this investment ETF. In such a case, the positive or negative impact of exchange rate fluctuations is, so to speak, a side effect. In that sense, those who are concerned about exchange rate fluctuations would be better off choosing the “currency hedged” type.
Incidentally, as of June 2022, “no currency hedged” type ETFs seem to be more popular than “currency hedged” type ETFs, perhaps due to the strong yen depreciation trend.
One variant is the “iFreeETF NASDAQ100 Inverse” ETF from Daiwa Asset Management. This ETF is designed to reverse the price movement of the Nasdaq-100 by investing in stock index futures and bonds, i.e., if the Nasdaq-100 rises 10%, the ETF’s price will fall 10%, and conversely, if the Nasdaq-100 falls 10%, the ETF’s price will rise 10%.
As is well known, the Nasdaq Index peaked in late November 2021 and has fallen sharply, but if you hold instruments related to the Nasdaq-100 for long-term holding purposes, you can hedge against a price decline by purchasing this ETF.
Other Nasdaq-100-linked products
In addition to mutual funds and ETFs, there are also futures and CFDs (Contracts for Difference) related to the Nasdaq-100, which are listed on the CME (Chicago Mercantile Exchange), and some online securities companies offer products related to the Nasdaq-100.
As the Japanese translation of the term “Contracts for Difference” indicates, CFDs are a type of derivative (financial derivative) instrument that allows traders to earn profits from the difference between the purchase and sale prices, using the margin deposited as collateral. In Japan, Click Kabu 365, a margin trading service of the Financial Securities Exchange, started handling Nasdaq-100 CFDs on February 28, 2022.
With a margin of 7,240 yen as of June 6, 2022, the Nasdaq 100 CFD allows investors to trade the Nasdaq 100 index multiplied by 10 yen, which is about 20 times leverage. While this is a high risk, the attraction is that it allows investors to invest in the Nasdaq-100 with only a small amount of money.
In terms of leverage, the SOMPO Switch NASDAQ 100 Leveraged 2.5x, which began operations on May 9, 2022, is also interesting. It is a mutual fund designed to aim for a price movement of 2.5 times that of the Nasdaq-100 and to eliminate price volatility by removing positions held in the event of increased downside risk in the Nasdaq-100.
In addition to the products discussed here, there are hundreds of other investment products around the world that are linked to the index. In any case, if you are considering practicing asset management, we recommend that you include an investment in the Nasdaq-100 as one of your candidates, as it allows you to collectively invest in the world’s innovative and leading companies and has recorded quite a high performance to date. Of course, good past performance does not necessarily guarantee good performance in the future.
The Nasdaq-100 meets the detailed needs of investors, and products are expanding
The Nasdaq 100 is composed of companies that are expected to achieve high growth in the future, but its price movements tend to be more volatile than those of the S&P 500. Knowing this, some investors may be reluctant to invest in the Nasdaq 100. However, as we have shown, the Nasdaq 100 has a variety of related products, and it is a diverse index that can respond to the specific needs of each investor.
The companies that make up the Nasdaq 100 have grown in a way that has defied the headwinds of the COVID-19 pandemic. Their brand power and growth potential are unrivaled, and they will continue to increase their presence as a driving force for companies around the world. Although the stock price has recently undergone a major adjustment due to the shift in U.S. monetary policy, it is likely that it will eventually turn higher for these reasons.
Rather than investing all of your capital at once, you can expect large returns over the long term if you take the current adjustment phase as a buying opportunity and repeat the investment behavior of “buying when the market falls sharply.”
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