The cap-weighted version of the S&P 500 has its bouts – some recent with elevated concentration. The same goes for the Nasdaq-100 Index (NDX) because that benchmark, as its name implies, is home to a smaller number of components.
Additionally, NDX excludes financial services and is historically overweight to the technology sector in dramatic fashion relative to other broad market indexes. Investors can reduce that concentration risk with exchange traded funds, such as the Direxion NASDAQ-100 Equal Weighted Index Shares (QQQE ).
QQQE follows the Nasdaq 100 Equal Weighted Index (NETR), the equal-weight counterpart to the aforementioned NDX. Some interesting historical trends indicate that QQQE could be a valid near-term consideration for equity investors.
“Using the historical adjusted HHI (Herfindahl-Hirschman Index), we’ve previously established that concentration tends to mean-revert in most sectors. Changes in concentration affect the relative performance of the equal-weighted versions of each sector,” notes Anu Ganti of S&P Dow Jones Indices. “Equal-weighted sectors tend to outperform after peaks in their sector concentration. This is particularly noticeable for Information Technology.”
Historically, the cap-weighted Nasdaq 100 is significantly overweight to the technology, communication services, and consumer discretionary sectors relative to other broad market gauges. That leads to large weights to individual stocks from those sectors, including Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), and Amazon (NASDAQ:AMZN), among others. That means mega-caps often chart the course for NDX, but investors may want to consider tapping into the size factor from time to time.
“Changes in equal-weighted relative performance and changes in concentration are not two separate things, but two aspects of the same thing,” Ganti adds. “If larger stocks outperform smaller ones, concentration will increase, and equal weight will underperform. Similarly, if smaller stocks outperform, concentration will decrease, and equal weight will outperform.”
Currently, NDX allocates over 85% of its weight to three aforementioned sectors, while QQQE’s weight to those groups is just over 68%. Additionally, the individual stocks in QQQE each command a weight of just 1%, which significantly reduces single-equity risk. Other factors could bode well for the Direxion ETF over the near term.
“Since Information Technology and Consumer Discretionary’s adjusted HHIs are at historically high levels, equal weighting within these sectors might be worth considering rather than cap weighting, since concentration tends to mean-revert over time,” concludes Ganti.
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