Just How Will The NASDAQ’s Special Rebalance Work, Exactly?!
What about the NASDAQ-100 rebalance? What is going on there?
Well, first off, the Nasdaq corporation is doing a great job selling Pebble and why we have built this firm. As you will read below, they have raised some thorny questions around just why so many products are based on a suboptimal index and the broader question of:
Why are so many people invested in such poor financial products?
But first off, we should say: we really appreciate their hard work here.
Second, want a better index? At a better cost? Download here and get started today.
Further, on this theme we wanted to provide more information on the NASDAQ rebalance. To the best of our knowledge here is what the plan currently looks like:
The line in the red box on the far left is the weight per company before the announced rebalance while the middle blue is what they are expected to become after July 24th.
The final column in the red box on the right is how many basis points (or percentage points) a company will be expected to gain or lose. A loss is represented by being in brackets. i.e.: (104) is -104 basis points or -1.04%.
As you can see there are some surprising companies standing to gain from a larger % weight in the NASDAQ-100. We were pretty interested to see non-tech Pepsi ($PEP) and Costco ($COST) alongside the more typical Broadcom ($AVGO), Adobe ($ADBE) and Cisco systems ($CSCO) in the top 5 winners.
We will save why Pepsi is in the NASDAQ-100 index for another time.....
For now, we would really still caution against running out and trying to optimize your portfolio for the above change. We looked back at Nasdaq's 2011 special rebalance of Apple and it seems that it impacted the company not at all.
That fits with our previous expectations and we have been unable to come up with anything to meaningfully change our mind over the last week.
So, if you loved Apple two weeks ago and thought it was a $3 trillion dollar company then it is very difficult why changing its index weight will change how you think any differently about the company, one way or another.
As a reminder, here is what is happening to the largest "Super 7" companies being rebalanced:
In the end this will mean that, over the very short term, passive investors will experience some changes in their indexes but rather than try and do anything sophisticated about that you might want to simply use this opportunity to review why you own, what you own.
Owning the NASDAQ-100 (or any of its derivative ETFs or Mutual Funds based on the index) might be somewhat sub-optimal for a few reasons. This is especially the case right now if you would rather not own more Pepsi and less Apple, for instance?
But more broadly, this rebalancing raises the important question of why so much is based on such a narrow and overly concentrated index in the first place?!
On that very subject, we were gratified to see Goldman Sachs' strategists agree with our position and argue that they don't believe this re-weighting will: "solve the challenge that elevated current market concentration poses for many benchmarked investors.”
They also helpfully pointed out that:
“Even after the rebalance, the NDX will remain too concentrated to be considered an actively managed “diversified” fund according to the SEC (stocks greater than 5% weight will total 32% of the index).”
Which was another point we had not fully considered from a regulatory viewpoint. Long story short, if you are looking for a stable and well-diversified index, the NASDAQ-100 is not an ideal choice.
Why mention this rebalance at all if we would not recommend doing very much of anything?
Well, very simply:
Forewarned is forearmed.
Better to understand what exactly is happening here before it goes down.
Though we don't expect this to be the case, we could always be wrong and this could occur for the S&P 500 and other major US indices in the months to come.
In the end, we actually think that this rebalance may prove unnecessary when we look back in a few months. Yes, these few very large technology companies have gotten far larger this year and yes, they breached Nasdaq's internal regulations but:
More importantly, this should perhaps kick off a deeper conversation about what exactly is going on here?!
By that we mean that the bigger point is why does Nasdaq have such a structurally unsound index in the first place and why do so many financial products - like ETFs such as the hugely popular and widely held Invesco QQQ - are based on such a narrow and easily unbalanced collection of stocks.
That inherent weakness doesn't get talked about enough by those selling or marketing the financial products really ever.
More significant still, it also essentially unmentioned that the NASDAQ-100 was created in 1985 (!!) which is, of course, nearly 40 years ago.
Why is everyone buying an ETF based on a 40 year old index that only has 100 companies in it? Seems not just bizarre but also unwise.
Helpfully the passive investing landscape is finally changing very rapidly.
Thanks to technology and the move away from expensive curated financial products there are fewer and fewer reasons that investors need be trapped by some decision that was made years ago in some office of a company they have never even heard of and likely wouldn't think very much of if they did.
Rather they can come to a place like Pebble where we will make sure you don't stumble into some over priced financial product based on some fundamentally flawed index built 40+ years ago for a bygone age. Then, even better, you can personalize it to suit your own needs and values.
Think about it: You wouldn't buy a car based on 40 year old technology. Heck, you wouldn't buy a coffee machine or - shudder - a 1980s airplane ticket that would come with a section for people to SMOKE CIGARETTES SEPARATED FROM OTHERS BY A POLYESTER CURTAIN either.
So, the time has come. You can now invest in a modern index for a modern world and also one built for you not some bygone age that thought hacking a butt at 36,000 feet was a necessary part of a modern society.
Get the next step in the evolution of the ETF and avoid higher costs, structural weaknesses and the financial equivalent of the risk of flying on a plane with the Marlboro Man.
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Have questions? Care to find out more? Feel free to reach out at contact@pebble.finance or join our Slack community to meet more like-minded individuals and see what we are talking about today. All are welcome.
