[This following "ETF Issuer Perspective" is sponsored by Nasdaq]
To some investors, it might seem odd to limit a tradable index to a single exchange and then to constrain those securities listed on that exchange by sector. But applying these two nuanced rules has resulted in noteworthy price performance over the past 10 years. The index being referenced is the renowned Nasdaq-100.
It could be argued that the Nasdaq-100 Index is not just a liquid, tradable benchmark but that in fact it has become the best equity manager of the past 10 years. Here’s why …
Much like the S&P 500 is not the representation of the 500 largest U.S. companies by market cap or the Dow Jones Industrial Average being the 30 biggest names of industry, the Nasdaq-100 is not a broad market, broad-based benchmark. The Nasdaq-100 represents the Nasdaq, and as a result, it represents growth, innovation and ambition. The S&P 500 is meant to represent U.S. large-cap, yet companies are included that are not large-cap. Dow Jones places more weight on Goldman than Apple. The Nasdaq-100 represents some of the most-well-known brand names in today’s global economy, the names of companies that have innovated industry after industry.
For background, the Nasdaq-100 is comprises the 100 largest, nonfinancial companies listed on the Nasdaq Stock Market. It was launched on January 31, 1985, as a marketing tool to help highlight companies listed on The Nasdaq Stock Exchange®. Since Nasdaq, at that time, was home to many financial stocks, it decided to create two distinct indexes: one to showcase the financial names (Nasdaq Financial-100) and the other to showcase the nonfinancial names (Nasdaq-100). In 1998, Nasdaq decided to turn the Nasdaq-100 into a tradable product and thus allow the world to invest in the top 100 nonfinancial names listed on Nasdaq via a single share of stock. This coincided with a tech bull market, so interest in this type of product was high. From its first listing as an ETF in March 1999 through today, the Nasdaq-100 has returned more than 15% higher than the S&P 500. Not bad.
The Nasdaq-100 uses a modified market-capitalization methodology that was created to ensure proper size representation across the names and meet the Investment Company Act of 1940’s diversification test. The modified market-capitalization methodology rebalance has been run twice—December 1998 and May 2011. The May 2011 rebalance resulted in the index-weighting modification factors being set to 1, so for all intents and purposes, the index is now market-cap-weighted. In other words, since the May 2011 rebalance, the largest name has the largest weight, and smallest name has the smallest weight.
The index, much like the underlying market that it tracks, has changed dramatically since its launch more than 30 years ago. Taking a closer look at the last decade, the Nasdaq-100 has evolved into a benchmark for large-cap companies renowned for innovation and growth. Today the components that make up the Nasdaq-100 are fundamental giants that have disrupted the old economy with creative products and services, and have become the new industrials of the 21st century. What is the result? Increased earnings, increased dividends, decreased valuations and a significant increase in price. Quite frankly, if you were to strip the name, the rules and the legacy away from the Nasdaq-100 and simply look at fundamentals and performance, you would find an astoundingly successful equity manager. And its performance has not been capacity-constrained because interest and investment within the index has only grown. The components of the Nasdaq-100 have been called modern-day industrials. Where GE, Chicago Gas, American Sugar and other original Dow components powered the growth of the early 20th century, Apple, Microsoft, Cisco, Google, Qualcomm, Amgen and others power the economy today. From office life and coffee consumption, to daily commutes and knee replacements, every facet of our economic life worldwide is fueled by the companies within the Nasdaq-100. The results, from a financial perspective, are impressive. Since 2003, the components of the Nasdaq-100 have achieved a compounded annual growth rate of 26% in earnings, 13% in revenue and 33% in dividends paid, all while experiencing a 15% reduction in valuation (as measured by the P/E ratio). The chart below showcases the dramatic shift in fundamentals relative to the S&P 500. The Nasdaq-100 of today has undergone a fundamental transformation from the Nasdaq-100 of the tech boom era.