The Nasdaq-100 – Foundation for the Future

If you are interested in gardening, you may have purchased a seed kit to get started. A seed kit often comes with seeds of various kinds of vegetable and fruit plants that can be grown in the quantity or mix that makes the most sense. It will have seeds for plants that bloom in different climates or different times of the year, and from this kit are innumerable options for organizing your farm or garden. In theory, you could have a farm or garden with only one crop, but your family would quickly tire of eating strawberries or potatoes every day, and if the weather or a blight wiped out your crop, you would be out of luck.

Building an investment portfolio is similar to buying a seed kit. Investors want to begin with exposure to securities that will grow, but also represent variety so they have a broad exposure to different industries. One highly popular seed kit for structuring a strong portfolio continues to be the Nasdaq-100.

Strong Performance

The Nasdaq-100 index is comprised of the top 100, non-financial companies by market cap listed The Nasdaq Stock Exchange. The index represents growth, innovation and ambition. It was launched on January 31, 1985, to help highlight companies listed on The Nasdaq Stock Exchange. Today, Nasdaq is known for being the preferred exchange for technology companies. In 1985, Nasdaq was home to many financial stocks. As a result, Nasdaq decided to create two distinct indexes: one to showcase the financial companies (Nasdaq Financial 100) and the other to showcase the non-financial companies (Nasdaq-100).

In 1999, Nasdaq decided to turn the Nasdaq-100 into a tradable product and thus allow the world to invest in the top 100, non-financial companies listed on Nasdaq via a single share of an exchange-traded fund (ETF). Strong interest in tech stocks at the time translated into strong interest for the newly launched ETF.

Looking at returns from December 2003 to December 2018, the Nasdaq-100 Total Return Index (XNDX) has returned more than 236% higher than the S&P 500 Total Return Index (SPXT).

XNDX

SPXT

Cumulative Return

491.28%

255.12%

Annualized Return

12.80%

8.97%

Annualized Volatility

20.32%

18.21%

Fundamental Data: Nasdaq-100 vs. S&P 500

The components of the Nasdaq-100 have been called modern-day industrials. Whereas GE, Chicago Gas, American Sugar and other original Dow components powered the growth of the early 20thcentury, Apple, Amazon, Microsoft, Google, Netflix and others power the economy today. From the coffee you drink in the morning to the movies you watch at night, so much of our life is connected to companies within the Nasdaq-100. The results, from a financial perspective, have been very impressive. From December 2003 to December 2018, the companies that make up the Nasdaq-100 have achieved a compounded annual growth rate of 22% in earnings, 13% in revenue and 29% in dividends paid, all while experiencing a 11% reduction in valuation (as measured by the P/E ratio). The chart below showcases the dramatic shift in fundamentals relative to the S&P 500. The Nasdaq-100 of today has undergone a fundamental transformation from the Nasdaq-100 of the tech boom era of the turn of the century.

While the Nasdaq-100 is known for its technology company focus, with the likes of Facebook, Amazon, and Google, if we look closer, these companies transcend sectors and industries. Amazon is an e-commerce company, while also taking in a significant amount of revenue from its cloud computing service, and in 2017 had a higher video production budget than HBO. Google, the impressive search engine, makes most of its money through advertising products, and has also entered the hardware spaces including mobile phones and self-driving cars. Similarly, Facebook is a social network giant, but has branched into virtual reality products and offers a variety of video hosting services.

Not Secret, Reclassified

The Nasdaq-100 is additionally attractive due to less exposure to what is called reclassification risk. Periodically, the two organizations that classify companies for the purpose of indexing and benchmarking, GICS and ICB, will change a companys classification based on its profile. While this helps to keep classification accurate, it poses a risk to thematic and other indexes that are based on company classifications. If a company classified as a consumer company is dominant among its peers because of its mastery of technology, it may be reclassified as a technology company. That means it may drop from indexes that require defined consumer companies to populate the index based upon its strategy.

With the Nasdaq-100 index, this reclassification risk is substantially subdued. Reclassification risk has only one avenue with Nasdaq-100 companies, that being if a company is reclassified as a financial company. It is possible that some of the decidedly non-financial companies may be reclassified as a financial company-for example, a technology company that comes to dominate online banking. But that is much less likely than other lateral moves among company classifications we normally associate with this risk. Where companies are more likely to be removed from the Nasdaq-100 is if they are no long within the top 100 companies by market cap.

Plant a Seed

While the Nasdaq-100 changes, it changes in accordance with market capitalization, and the fundamental thesis of high-growth, technology and innovation-centered wide exposure has proved for more than 20 years to be a winning formula. The index has the diversity, liquidity, and lasting performance and value that is the core of every valuable portfolio. Its transparency and accessibility make it the perfect index ambassador for Nasdaq and a standard-bearer for our age of technology and change. After more than two decades providing value, the Nasdaq-100 Index remains a compelling seed kit for a global portfolio.

Neither Nasdaq, Inc., including of its subsidiaries and affiliates (collectively, “Nasdaq”), nor any of the Nasdaq third party information providers (“Information Providers”) (nor any of these entities officers, employees, directors, or agents): (1) has passed on the merit of any of these securities; or (2) has endorsed or sponsored any of these securities. The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy.ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.

Dave Gedeon is VP and Head of Research and Product Development for Nasdaq Global Indexes