Nasdaq 100 Rebalance to Shake Up Index, Tech ETFs

As favorite stocks are culled, fresh opportunities may arise with new-look QQQ.  

As favorite stocks are culled, fresh opportunities may arise with new-look QQQ.    

Let’s put this one under the category of obscure ETF regulations that few care about … until a good reason to care appears. That’s what will occur Monday, July 24, when one of the most popular exchange-traded funds around, the Invesco QQQ Trust (QQQ), will be forced to cut the allocation weightings of the very stocks that have led it to a historic first-half run.   

From the standpoint of the Nasdaq-100 Index, this is a case of a small number of stocks being a victim of their own success. For big institutional money managers, the Investment Company Institute has a diversification rule that has never come into play. That’s because we’ve never seen such a top-heavy weighting in the stock market.  

Specifically, institutional investors may not hold a fund if the total weight of all individual stock holdings of at least 5% combine for more than 50% of the exchange-traded fund. This rule was breached at the start of July, when just six stocks accounted for more than 50% of QQQ. 

Fortunately, ETF investors in QQQ and other Nasdaq-100-heavy funds have good visibility into Monday's event, and what the biggest changes are likely to be. That allows them to take this opportunity to determine if they want to make adjustments to their Nasdaq exposure. In a year in which QQQ is up 42%, this may be considered a convenient excuse to reassess.  

Nasdaq-Heavy ETFs, Tech ETFs

For others, this might be akin to having their Nasdaq-heavy ETFs do some heavy lifting, since this rebalancing has the effect of shaving off excess risk and doing some prudent profit taking, while maintaining the majority of their exposure to today’ glamor stocks. 

Naturally, ETFs like QQQ, which are strict Nasdaq-100-tracking ETFs, will be impacted precisely in line with the changes to that index on Monday. But there are other ETFs that have some overlap with QQQ but already offer a way to have one foot in the Nasdaq-100 door, so to speak, but perhaps take advantage of a growing opportunity outside the stocks that are dominating performance this year. 

The $1.0 billion Direxion NASDAQ-100 Equal Weighted Index Shares (QQQE) is an 11-year old ETF that is up 25% so far in 2023. Its equal-weighted structure means it is impossible to violate the diversification rule, since every holding’s weight is very small. It has flown under the radar thanks to QQQ’s dominance, and the outperformance of that small group of market megastars.  

For those interested in considering having some Nasdaq exposure with a twist, the VictoryShares Nasdaq Next 50 ETF (QQQN) is worth a look. At just under $100 million in assets, the fund is essentially a way to extend a bit further down the Nasdaq Composite’s weighting system by owning the stocks just outside of the Nasdaq-100. Importantly, QQQN rebalances and reconstitutes its portfolio quarterly, so it can respond dynamically to the varying fortunes of its focused holdings list. 

The Nasdaq-100 rebalancing event we’ll see on Monday has been in the rule book for a long time. But like a comet that comes around rarely, this has the potential to shake up some big money portfolios in a way we have yet to see in practice, and perhaps may not be able to fully anticipate.