You could say that when it comes to the Invesco QQQ Trust (QQQ), there’s no such thing as bad publicity.
The 20-year-old veteran—one of the early ETFs to come to market—has faced its share of expert shrugging over the years given the quirky benchmark it’s designed to track, the Nasdaq-100. And yet investors keep on piling into this ETF, unphased by the naysayers, through its many ups and downs.
Year to date, QQQ has attracted nearly $17 billion in net new money, making it one of the year’s most popular funds. It crossed the $100 billion-in-total-assets milestone in May, and has kept on growing, now a $135 billion ETF. Only a handful of funds can claim such accomplishment.
(Annual flows for QQQ relative to the SPDR S&P 500 ETF Trust (SPY) at a glance):
Strong performance has certainly helped in its rise. Year to date, QQQ is up five times more than the S&P 500, and significantly more than the Dow Jones Industrial Average (as measured here by SPY and the SPDR Dow Jones Industrial Average ETF Trust (DIA)):
QQQ also outperformed SPY and DIA in 2019, 2018, 2017, 2015, 2014, 2013, 2012, 2010—in eight out of the past 10 years. It’s currently on track to repeat that feat in 2020.
But QQQ, impressive as it is, lives caught somewhere between conflicting expert and popular opinion.
What do some ETF experts gripe about? The design of the Nasdaq-100 itself underlying QQQ.
Index Design: Rules, Rules
QQQ is a passive strategy launched by Nasdaq in 1999 as the Nasdaq-100 Trust, and later acquired and renamed by PowerShares and Invesco in the early 2000s. The fund is designed to track that benchmark as closely as possible, delivering the same results minus fees, which makes a criticism over the index apply to the fund as well.
The index is rules-based, but many argue that the rules seem "arbitrary" when it comes to both stock selection and weighting.
• Stocks in the Nasdaq-100 must be listed on the Nasdaq, and they must not be in the financial sector.
That’s akin to making home address the primary selection criteria, with the added twist that not all homes on the street are in. The resulting universe of stocks has been aptly described as a mix of “what’s working now for Nasdaq,” rather than a true large cap tech growth portfolio, as many consider it. QQQ is today approximately 63% allocated to technology companies led by Apple and Microsoft.
• The modified market cap weighting scheme looks to accommodate for position limits—25% in ’40 Act Funds. Every time a limit is hit or when Nasdaq sees too much concentration at the top and deems it needed, a rebalance takes place, redistributing some of that weight to smaller holdings. That rebalance can take place at any time at Nasdaq's discretion, even outside of the benchmark’s regular rebalance schedule.
To quote FactSet Director of ETF Research Elisabeth Kashner, the weighting of the Nasdaq-100 “is more accurately described as a cap-weighted index with caps, and sometimes an equal-weighted tier in its middle. The Nasdaq-100's methodology document has a clear provision for a ‘special rebalance schedule’ specifically for enacting the cap-and-redistribute weighting.”
Does that mean the Nasdaq-100 index rules are merely guidelines?
“It's hard to say that the index breaks its own rules,” Kashner said. “But it is fair to say that the rules open the door for off-cycle rebalances that may well surprise investors.”
Passive investors aren't exactly known for loving surprises. Then, again, 20 years of live history of QQQ tracking this benchmark suggests many investors are happy to take on the occasional shake-up, because as one ETF pundit put it, “QQQ is a great basket of stocks.”
“QQQ was one of the early entrants into the ETF market that came to be at the end of the technology boom, and that survived the tech bust,” CFRA’s Director of Mutual Fund & ETF Research Todd Rosenbluth said. “Those who have long enough memory see QQQ as synonymous with recovery.”
Recent Nasdaq research highlights that point: “For those who were invested in NDX (the Nasdaq-100) at year-end 2009, the rewards during the past 10 years have been superb. The index’s outperformance of the S&P 500 (SPX) is likely beyond what most financial forecasters could have guessed 10 years ago, and even gives the dot-com bubble of the 1990s a run for its money.”
Here’s what that performance looks like between year-end 2009 and year-end 2019:
Charts courtesy of StockCharts.com
Tough Index To Understand
“No one really understands this index, true, but we’ve been living in this tech, growth-oriented bull market, and QQQ has no comparable ETFs. There’s no ‘IVV’ or ‘VOO’ equivalent,” Rosenbluth said, adding that QQQ is “reasonably priced” relative to mutual funds at 0.2% in expense ratio, so there isn't much incentive to look elsewhere.
As an ETF, QQQ is also immensely liquid, trading on average some $12 billion a day at pennywide spreads, and it tracks its index really well, with median tracking error sitting at -0.26%. (That’s the median difference between QQQ and its underlying index performance over 12 months.) This is a fund that does its job extremely well.
Maybe It’s All In The Brand
Perhaps QQQ's success is a simple story of brand value. Many see Nasdaq as the home of growth and big tech stocks. QQQ is the wrapper that encapsulates that. There’s value in that brand.
The fund certainly has the marketing chops to ensure brand awareness is never a deterrent to its adoption. As a grantor trust, QQQ clearly states in its prospectus that 0.05% of its fees is to be spent on marketing for the fund.
So far this year, QQQ’s $135 billion asset base means fee revenues of about $266 million, $66.5 million of which is to be spent on marketing, according to the prospectus. If you were to think about what $66.5 million means in terms of, say, advertising, it means that for roughly every 10 ads you see for companies like Allstate, Walgreens or Discover Card today, you’d see one ad for QQQ. For every two United Airlines ads, you’d see one for this ETF.
Marketing spend doesn’t necessarily translate to ad impressions, but the broader point is that QQQ is very committed to reaching its audience. And we know that ETF distribution—getting a fund in front of the investor—is a big part of the battle toward success in this marketplace.
What Investors Want: Tech, Growth, ESG
Another twist to the brand value story is that QQQ has strong appeal with Gen-Y and millennial investors, according to Nasdaq, who see the benchmark and its tracking ETF as vectors to exactly what they want most.
Citing various research, Nasdaq points to investor preference for technology stocks, as well as for companies they believe in that meet some environmental/social/governance (ESG) criteria. Above all, they prefer ETF wrappers to access those things. The confluence of these trends has brought many investors to the Nasdaq-100 and to QQQ over time.
One example is the 2019 Apex Clearing “Millennial 100” list—the 100 stocks millennials bought most last year. The list is peppered with names found in the Nasdaq-100 and QQQ: Amazon, Apple, Microsoft, Tesla, Netflix, etc. The overlap between what the strategy delivers and what investors want was significant.
(Use our stock finder tool to find an ETF’s allocation to a certain stock.)
“Based on Apex Clearing's numbers, NDX components represented nearly 55% of cumulative millennial holdings in the Apex 100 at that time,” Nasdaq said in its research note.
Know Your Goal & Your Options
Effective as QQQ’s marketing may be, and as strong as its and the Nasdaq-100’s brand are with new waves of investors looking for access to growth, tech and even ESG themes we can’t seem to get enough of, a little word to the wise about ETF choice, courtesy of FactSet’s Kashner: “Before you enter the buy order for QQQ, be clear about what you're hoping to achieve.”
“If you want to buy Apple, buy AAPL. After all, 86.6% of QQQ is made up of stocks that are not AAPL,” she explained. “If you want technology exposure, consider pure-play tech ETFs such as ‘VGT’, or even ‘new technology’ ETFs such as ‘XITK.’ If you want growth, consider growth ETFs like ‘MGK.’ But if nothing but QQQ will do, at least you can rest assured that you'll find easy execution and tight tracking.”
Contact Cinthia Murphy at [email protected]