Client Question: NASDAQ 100 Rebalance

July 20, 2023

The news media has been discussing a relatively rare occurrence this week – a special rebalance of a key market index. A client asked me why it’s happening and what it may mean for markets and individual companies. Let’s take a look

What is the NASDAQ 100?

The NASDAQ 100 is a common equity market index (like the S&P 500 and the Dow Jones Industrial Average). The NASDAQ and other indexes are used as a way for market participants to track the market’s progress and to benchmark/compare their own performance. They’re also used as a way for investors to easily “buy” large swaths of the market as countless investment products such as exchange traded funds and index mutual funds are structured and pegged to these indexes – NASDAQ included.

How is the NASDAQ 100 compiled?

The NASDAQ 100 includes the 100 of the largest non-financial companies listed on the Nasdaq stock exchange. Given the nature of the companies that tend to list on the NASDAQ, the NASDAQ 100 index has historically been viewed as a barometer for growth and technology names.

The index is a modified market capitalization-weighted index. In a pure market capitalization index, the constituents are weighted by their market cap (ie: share price & number of shares outstanding). This results in the biggest companies (ie: the ones with the largest market caps) representing the greatest amount of the index.

The “modified” comes into play as there are rules and guardrails governing indexes like the NASDAQ, preventing any one constituent from taking on too big of a weight. These controls are key given the amount of money tied to indexes and the need for concentration risk to be managed. The NASDAQ 100 has over $300 billion in assets tracking its performance, with $200 billion in the QQQ (the NASDAQ 100 ETF alone) – so it’s essential the index maintains its integrity and relevance.

Super 7 Surge

As you be aware, some of the largest US companies have surged this year. Their gains have represented a material amount of the broader market returns – leading to them being dubbed the Super Seven (or Magnificent Seven if you prefer). These companies include Apple, Amazon, Microsoft, Nvida, Tesla, Google, and Meta. Everyone of these names are part of the NASDAQ 100 and collectively account for over 55% of the index.

Special Rebalance

The NASDAQ 100 has a set of governing rules, which include a rule that constituents with individual weightings exceeding 4.5% don’t surpass a combined 48% of the entire index, per the company’s methodology. At present day, the index is in violation for this rule largely due to the names noted above (total reaching 55%+ in recent weeks).

The NASDAQ 100 has policies in place that allow for a special rebalance (beyond its normal quarterly process) at any time “based on the weighting restrictions described in the index rebalance procedure if it is determined to be necessary to maintain the integrity of the Index.”

The special rebalance will not result in the removal or addition of any securities. Instead, it is intended to reduce the index’s concentration in its largest constituents.

Special rebalances of the Nasdaq-100 have happened only twice before in 1998 and 2011

What’s likely to happen?

The rebalance, taking place on July 24, will result in the weights of names in the index being adjusted (again – no companies are being added or removed). While the details are not known, it is likely that the large companies noted above may see their weights reduced. And others may see their weights increased (names that have been mentioned include Starbucks, Booking Holdings, Mondelez, and Intuitive Surgical).

As these names will be bought or sold by index-tracking investments, there is a chance for some near term volatility in the names that are part of the rebalance. However, with the size and trading liquidity in these names, it’s unlikely there will be a lasting impact on the pricing. But time will tell!

The rebalance will change the holding weights within a critical index – one with over $300 billion tracking its composition and performance. If you are among the investors in such products, be sure to follow the rebalance and assess your underlying holdings post-rebalance to ensure they are in line with your overall investment portfolio and objectives.

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