How Should Investors Prepare for Nasdaq-100 Special Rebalance?
The $NASDAQ 100 Index (.NDX.US)$, which tracks the biggest non-financial US companies, is lacking diversity due to a concentration of a handful of tech and tech-ish firms outperforming other stocks. The index has undergone a special rebalance only once before, and it will happen again next week.
Why does it need to be rebalanced?
The Nasdaq-100 distributes investments based on market capitalization, with larger companies receiving a greater share than smaller ones. For instance, investing $1,000 in a fund with 100 firms may mean the largest firm receives 5%, while the smallest receives only a fraction of a percent. While market-cap weighted indices are generally fine, the Nasdaq-100 is currently more unbalanced and top-heavy because of the significant gains made by the top few companies. Presently, the top six companies account for over 48% of the index. Individual members cannot carry an index weight exceeding 24%, nor can collective issuers with weights greater than 4.5% account for over 48%.
Earlier this month, six issuers briefly accounted for over half of its total by weight, tripping the latter threshold after $Tesla (TSLA.US)$ hit a 10-month high, prompting intervention.
How will it impact the market?
The big-seven issuers will see a reduction in collective weight from 56% to 44%, with $NVIDIA (NVDA.US)$ and $Microsoft (MSFT.US)$ being most affected and losing around 3 percentage points. Their weight will be shifted to smaller caps, and the changes will come into effect on July 24, before the opening of the market.
Passive mutual funds and ETFs worth $251bn are benchmarked to the NDX, along with $10bn in active funds. About $20bn of short money is also invested in relevant ETFs. While rebalancing by passive funds can create some churn, it is difficult to predict the extent of the effects. The top-seven NDX stocks outperformed the index last week, suggesting that anticipatory trading may not significantly impact the market. According to $Goldman Sachs (GS.US)$, only $Alphabet-A (GOOGL.US)$ has an overhang of passive sales equivalent to more than a day's average volume among the top 25 constituents, while $PepsiCo (PEP.US)$, $Costco (COST.US)$, and $Honeywell (HON.US)$ are expected to be the ones to watch for passive buys.
YTD only 31% of large-cap funds are outperforming their benchmarks. However, only $10 billion of active mutual fund AUM is benchmarked to the NDX, compared with $805 billion for the Russell 1000 Growth and $2 trillion for the S&P 500," according to Goldman Sachs.
Since the previous rebalance in 2011 was quite uneventful, people tend to believe that whatever volatility happens would be temporary.
Source: The Motley Fool, Financial Times, Goldman Sachs
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
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WizIT : Great info. Thanks!