Nasdaq’s Extraordinary Rebalance, ExplainedJul. 17, 2023
The Nasdaq-100 index will undergo a special rebalance, effective prior to the market open on July 24,1 to redistribute the Tech Giants’ weights and offset their dominance. What does it mean for investors?
- BMO Nasdaq 100 Equity Index ETF (Ticker: ZNQ)
- BMO Nasdaq 100 Equity Index ETF (USD Units) (Ticker: ZNQ.U)
- BMO NASDAQ 100 Equity Hedged to CAD Index ETF (Ticker: ZQQ)
Why a rebalance is due
In an event that has only happened twice prior to this,2 the Nasdaq-100 Index will undergo a special off-cycle rebalance to redistribute its top holdings and remove some of the concentration in mega-cap Tech stocks. This may have come as a surprise to some, given the index is typically rebalanced quarterly with the latest having occurred in June — only a month prior.
This is, however, an extraordinary circumstance. The big six names in the index — Microsoft, Apple, Nvidia, Amazon, Alphabet and Tesla — rallied significantly year-to-date on the basis of artificial intelligence (AI) boom, making the Nasdaq-100 top-heavy. Going back to the late 1990s/early 2000s, many Canadians will remember when Nortel was dominating the index and skewing returns. The index is now facing a similar situation.
Within the index’s methodology,3 a special rebalance to reduce this concentration and ensure more diversification may be conducted under two conditions:
- If the largest constituents exceed the weight of 24%, or
- If the aggregate of all stocks, which have an individual weight of more than 4.5%, exceeds 48% in aggregate.
Microsoft — being the top holding — would not meet the criterion, as it has a weight of around 12.8%, as of July 7, 2023.4 However, over time, the big six stocks crept up, accounting for more than half of the index’s weight (50.89%, as of July 7, 2023).4
Nasdaq-100 Index Rebalancing
Advisors managing their own equity portfolios would need to manually adjust the allocations for each of their respective clients. However, the benefit of owning ETFs is that as the Nasdaq-100 reduces the concentration in its largest constituents, the BMO Nasdaq 100 Equity Index ETF (Ticker: ZNQ) and the BMO Nasdaq 100 Equity Index ETF (USD Units) (Ticker: ZNQ.U) will follow suit.
The impact from this special rebalance will likely be small and short-lived, given the large-cap Tech stocks have ample liquidity. For a name like Nvidia, which is up nearly 190%4 from January to the beginning of July, clearly the stock has been in demand, which will now be potentially offset with the additional supply. These names, all part of the “Magnificent Seven” Tech stocks, tend to be AI-related — a theme we believe will stick around.
As the Nasdaq-100 looks to reduce its concentration, where one stock (or group of stocks) outperforms the rest of the index, it will, essentially, take some of the winnings off the table to reinvest across other names. And there are a lot of other names to be excited about within the index, including Intel, Pepsi, Costco and Activision, which can be a very good thing for investors given most buy ETFs or index-based products for their broad-based diversification.
1(2023, July 7). The Nasdaq-100 Index Special Rebalance to be Effective July 24, 2023. Nasdaq, Inc. The Nasdaq-100 Index Special Rebalance to be Effective July 24, 2023 | Nasdaq
2(2023, July 11). EXPLAINER-What is Nasdaq’s special rebalancing and its impact? Nasdaq, Inc. https://www.nasdaq.com/articles/explainer-what-is-nasdaqs-special-rebalancing-and-its-impact
3(n.d.). Nasdaq Index Methodology - NASDAQ-100 INDEX®. Nasdaq, Inc. https://indexes.nasdaq.com/docs/Methodology_NDX.pdf
4Bloomberg, as of July 7, 2023.
5Morningstar, July 11, 2023.
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