The Worst Index In The World

April 05, 2011

If there’s a less useful index for investors than the Nasdaq 100, I don’t know what it is.

The Nasdaq 100 is the index behind one of the largest ETFs in the world—the PowerShares Q’s (NYSEArca: QQQ). According to this morning’s Wall St. Journal, over $300 billion of investor money is managed to the list of companies in the 100.


When we look at an index around here, we focus on two things: selection, and weight. The 100 is broken on both.

To get into the Nasdaq 100, here’s what you have to do:

  1. Happen to have Nasdaq as your primary listing
  2. Not be a financial company (for no particular reason)
  3. Be “seasoned,” which means being on Nasdaq for two years, or being in the top 25 percent of the Nasdaq 100 in terms of market cap

In other words, the list is based entirely on “what’s working now for Nasdaq.” Because of Nasdaq’s history as the home base of the dot-com bubble, the list is peppered with technology names, but also includes companies ranging from Staples to Sears. If a NYSE company wanted in, presumably all they’d have to do is change exchanges and wait six months. A rigorous selection process this ain’t.

But as arbitrary as the inclusion criteria for the 100 is, it’s the weighting scheme that really makes the 100 the worst index ever made by man.

As I wrote about last fall in a blog called “QQQQ Follies,” the index uses a modified market-cap weighting scheme but, in this case, that’s like suggesting that a garbage truck is a “modified” roadster—you could win a case in court on the distinction, and it would still stink.

Before Nasdaq wanted to launch mutual funds and ETFs based on the index—and what index owner doesn’t?—it was pretty vanilla, and Microsoft was over 25 percent of the index (back in 1998). To bring Microsoft down to an investable level (’40 Act funds have difficulties at 25 percent in any one holding), they created a crazy system that turned the 100 into a quasi-equal-weighted index.



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