ETFs

Dialing Back Risk While Maintaining Nasdaq-100 Exposure

For good reason, the Nasdaq-100 Index (NDX) is one of the hottest equity benchmarks this year and has been for some time. However, investors looking to reduce some of the risk associated with cap-weighted strategies while maintaining exposure to the NDX have options.

Consider the Direxion NASDAQ-100 Equal Weighted Index Shares (NYSEArca: QQQE) and the First Trust NASDAQ-100 Equal Weighted Index Fund (NasdaqGS: QQEW). QQQE and QQEW follow the Nasdaq-100 Index Equal Weight Index (NXDE).

Technology remains a favorite among investors, despite data suggesting technology stocks are relatively expensive as they trade at elevated price-to-earnings compared to the broader S&P 500. Equal-weight ETFs look to diminish unforeseen risks of traditional market cap-weighted funds by allocating to under-performing names upon rebalancing while reducing exposure to high fliers that could be ready to pullback.

“If an investor is looking to diversify within the universe of the Nasdaq-100, she can consider allocating to NDXE, the equal-weighted version of the NDX,” according to Nasdaq Global Indexes. “While not proven to be always superior from a return or risk perspective, NDXE offers investors the benefit of maintaining stable, 1%-each weightings to all 100 of NDX’s companies, rebalanced quarterly (as opposed to NDX’s annual rebalancing schedule).”

Lower Risk, Still Some Perks

Much of the advantage of afforded by equal-weight ETFs over time is attributed to either higher weights to small-caps or a tilt toward value names. With QQQE and QQEW, it's likely more a symptom of the former rather than increased value exposure because the Nasdaq-100, regardless of cap-weighted or equal-weight posture, is primarily a growth index.

Due to the significant presence of large-caps throughout the tech sector, it is not a stretch to say the advantage of equal-weight strategies in the tech sector, such as those espoused by QQQE and QQEW, come by way increased to smaller and mid-cap equities.

Equal weighting “means that there is less of an implicit bet on mega-cap firms in general. Instead of a weighted-average market cap of $755bn, NDXE’s average market cap of $128bn reflects an 83% reduction in the index’s typical constituent size,” according to Nasdaq Global Indexes. “Practically speaking, it means that if Microsoft, Amazon, or Apple (currently weighted more than 10% each in NDX) were to experience a particularly bad day or month or year (down 20%, for example), the impact of a loss is muted by more than 90%, reducing total portfolio drag.”

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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