Pro Vs. Con: The Nasdaq 100

February 26, 2015

John Jacobs: It’s more relevant today than it’s ever been. Thirty years ago, the Nasdaq-100 was just a list of stocks. Back then, the Nasdaq was the only market that took IPOs, so it was home to growth companies.

 

But the Nasdaq-100 is not just a tech stock index. We created back in 1985 two subindexes of the Nasdaq Composite, one focused on financials and one with everything else. So, the Nasdaq-100 doesn’t have any financials, but it doesn’t mean it’s all tech. If you look at the breakdown, it includes all sorts of industries. It’s a nonfinancial growth index, really.

 

At age 30, 50 percent of the stocks are paying dividends, which you would never have thought just a few of years ago. It’s been a great reflection of growth stocks in general in the U.S. No one would have thought that tech stocks like Apple were going to pay dividends. But now they are.

 

Over the years, there’s been a transformation in this index. It has gone from growth to large-cap growth, to large-cap growth with yield today. The index reflects the maturity of the growth companies in this country, and it’s again approaching record-high levels.

 

About the claims that it has an arbitrary weighting methodology, modified weighting was done one time back in 1998 to allow products like QQQ to be created, which is a unit investment trust. It’s back to a regular weighting scheme that’s more reflective of true market cap, although we can always apply a modified market-cap weighting if need be.

 

Dave Nadig: I tend to put the Nasdaq 100 in the same bucket with indexes like the Dow or the Nikkei: interesting from a historical perspective, but not from an investing perspective.

 

The core to picking any index should be "what's the investment thesis?" The MSCI All Country World Index intends to get you cap-weighted exposure to every company in the world, within investable reason. The Goldman Sachs Commodity Index tries to get you liquid exposure to commodities based on production. Those are reasonable approaches to tackling those problems.

 

What's the goal of the Nasdaq-100? To get you exposure to the largest companies that just happened to list on Nasdaq? That happen not to be financial companies? That's the first problem. There's nothing about listing on Nasdaq that makes a given company different, economically, from a company that chose to list on NYSE. It's an artifact.

 

If ExxonMobil decided to change from NYSE to Nasdaq, it would instantly have almost as much weight as Apple, just for making a listing decision. People think of the 100 as some kind of tech index, but if it is, it's entirely by accident.

 

Then there's the weighting mechanism. The 100's weighting scheme can be most generously called "arcane"—a bizarre system that lets large companies have large weight but then has a kind of quasi-equal-weight rebalancing scheme.

 

There's little academic justification for it, and for most investors, I imagine it just seems arbitrary. Further, the committee showed its willingness to just change the rules when they felt like it back in 2011.

 

I'll be honest: The Nasdaq is a fantastic exchange that’s pushed the entire global financial markets towards modernization, and most of the companies in the 100 are fantastic companies. But the actual 100 makes no sense at all.

 

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