NASDAQ 100 Special Rebalancing Will Hurt Returns

 | Jul 17, 2023 08:29AM ET

  • The Nasdaq 100 will have a special rebalancing after the close on July 21, 2023, to reduce the overconcentration in the most heavily weighted stocks in the index.
  • The rebalancing will likely drag down the Nasdaq 100 year-to-date (YTD) performance of 43.33%.
  • The Nasdaq 100 index is up 43.33% year-to-date (YTD), while the Equal-Weighted Nasdaq 100 index is up 24.17% YTD.
  • The S&P 500 index, which hasn’t triggered rebalancing, is up 17.98% YTD.
  • Index funds and ETFs that track the Nasdaq 100 will have to adjust their weightings accordingly by downsizing the heaviest market cap stocks and upsizing smaller market cap stocks as outlined by the Nasdaq.
  • Critics argue that this is rewarding underperforming companies while punishing strong performers.

    • On July 7, 2023, the Nasdaq announced it would implement a special rebalancing for the Nasdaq 100 index, tracked by the Invesco QQQ Trust (NASDAQ:QQQ) effective after hours on July 21, 2023, and pre-market on July 24, 2023. It will be based on the index securities closing prices and outstanding shares as of July 3, 2023. The spotlight has been drawn on the index's seven heaviest-weighted stocks, dubbed the Magnificent Seven.

    They account for 55% of the Nasdaq 100 index. The Nasdaq will adjust the weightings, not add or remove stocks from the index. What does this mean for the indexes?

    h2 Special Rebalancing Parameters/h2

    The Nasdaq regularly rebalances the index every quarter. The rally in Tesla (NASDAQ:TSLA) triggered the special rebalancing, pushing the aggregate weighting of the largest stocks over 48%. Of course, Tesla can't be completely blamed as the other company stocks have all risen, contributing towards the 48% threshold break.

    The Nasdaq can conduct a special rebalancing when the aggregate weight of its index stocks with more than a 4.5% index weighting exceeds 48%. The rebalancing aims to drop the market cap weighting to 40% while no other stock weightings can exceed 4.4%. The five heaviest-weighted stocks were Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL), NVIDIA (NASDAQ:NVDA), Amazon.com (NASDAQ:AMZN) and Tesla. Alphabet (NASDAQ:GOOGL) and Meta Platforms (NASDAQ:META) round out the Magnificent Seven.

    h2 What Does it Mean? /h2

    In a nutshell, the top five stocks will likely get weightings adjustments lowered to pull the aggregate weighting back down to 40%. Weightings will increase on smaller market cap stocks. It's spreading the investments to improve the breadth and not be concentrated in the heaviest-weighted stocks.

    Nasdaq will release the changes to the Nasdaq 100 index weightings, including which stocks will be downsized and which will be upsized.

    h2 What’s the Impact on Returns? /h2
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    The weighting adjustments will have an impact on the Nasdaq 100 performance. The initial result will likely be a pullback in performance as it sheds some of the best-performing stocks to date. The question is whether the effects from the upsized stocks will offset the effects on the downsized stocks in the final calculation of the index on the close of July 24, 2023.

    h2 Expect Nasdaq 100 Performance to Adjust Lower /h2

    In other words, the 43.33% year-to-date (YTD) returns on the QQQ will likely be lower when the smoke clears after the rebalance. Compare the current Nasdaq 100 QQQ ETF gains of 43.33% as of July 16, 2023, with the First Trust NASDAQ-100 Equal Weighted Index Fund (NASDAQ:QQEW) gains of just 24.17%. The rebalancing will not result in an equal-weighted Nasdaq 100, but it will likely dilute some YTD performance to fall between the 43.33% and 24.17% performance range.

    h2 Is the S&P 500 Next? /h2

    All this leads to whether the S&P 500 index, tracked by the SPDR S&P 500 ETF Trust (ASX:SPY), will follow along with its special rebalancing. Under current weightings, the heaviest market cap-weighted stocks in the index have yet to cross the threshold.

    The S&P 500 index rebalancing occurs when stocks heavier than 4.8% weight cumulatively exceed the 50% threshold of the total index. Only AAPL at 7.47% and MSFT at 6.76% weighting exceed the 4.8% threshold to qualify for the aggregate total surpassing 50%. The third heaviest market cap is AMZN, with a 3.18% weighting.

    Technically, there would be no need to rebalance the S&P 500 index, up 17.98% YTD. This overconcentration is a Nasdaq 100 issue, not an S&P 500 problem. However, that may not be the case when compared to the Invesco S&P 500® Equal Weight ETF (NYSE:RSP) YTD performance of just 7.75%, less than half of the S&P 500 index gains.