QQQQ Follies

October 20, 2010

Another day, another misguided attempt to paint the PowerShares QQQ Trust (QQQQ) as a great idea.

Andrew Hart, in a piece at GreenFaucet’s new ETF site, writes about how QQQQ is a shining example for bullishness trends. His premise is that, by following Nasdaq’s example in market changes, you can “distinguish the real emerging trends from the fakeouts.”

Sorry, I’m not buying it.

Hart plots out a chart comparing QQQQ’s relative strength against SPY, the 800-lb. gorilla of exchange-traded products. Using a focal point in September, he shows how, while both funds reacted to the market’s sharp upswing, QQQQ surged ahead of SPY.

“Spotting this relative strength of the QQQQ’s over the SPDRs (or QQQQ’s under the SPDRs, in bearish cases) can identify new trends as they emerge,” Hart writes.

He might as well be reading tea leaves.

We’ve talked before about how QQQQ is a convoluted disaster of a fund, based simply on its crackpot index-rebalancing scheme. Once a security crosses a monopoly threshold in the index—over 24 percent for any one holding—the excess money gets pulled out and divvied up between the biggest of the bottom-end stocks. This results in more exposure to the middle of the index. The idea is to “provide enhanced diversification of the underlying securities basket and result in a better representation” of Nasdaq as a whole.

The reasoning behind this incredibly bizarre quasi-equal-weight rebalancing scheme wasn’t academic, it’s commercial. Back when the rule was instituted, it was done to make the Nasdaq 100 an investable index. The last time this rebalancing happened was December 1998 (coincident, essentially with the launch of the Qs). Microsoft tripped the alarm, and a whole pile of money that was in Microsoft got moved, essentially, to the middle of the index, reweighting many under-1 percent holdings up to 1 percent, including a little company called Apple. The index has been living in an idealized version of December 1998 ever since.

Now tell me—how is an index that’s been frozen in a broken state since 1998 going to provide any indication of how the market reacts?

What it’s really doing is showing you how this one crazy rebalance has performed—for 12 years now—and how much the Nasdaq 100 has just become Apple. Since the first of the year, here’s the tale of the tape:

QQQQ Total Return: 11.89 percent

Performance Attribution (absolute)

% of Portfolio

Return Contribution


17.85 %

7.29 %


4.75 %

-.96 %

Every other security in the NDX fails to contribute in a truly meaningful way to this battle between Microsoft and Apple. A bet on QQQQ is not some mythological bet on “relative strength” and the lines on the chart are essentially meaningless. The returns of QQQQ have been and will continue to be dominated by this bet on the relative weights of Microsoft and Apple, and the rest is, frankly, noise.

Indexes do many things. Most of them are designed to actually represent segments of the market, and the investment thesis itself is a secondary consideration, left to the individual investor. Qs is an example of what happens when the best of intentions run up against the desire to create a product out of a broken index.

If you’re searching for Blackbeard’s treasure map to ETF success, QQQQ doesn’t mark the spot.


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