ETFs Ignore Impending Nasdaq 100 Overhaul Worth Trillions

A multitrillion-dollar revamp of one of the world’s largest stock market indices appears to have minimal impact on the exchange traded fund (ETF) sector.

The combined weighting of six tech giants – Microsoft, Apple, Alphabet, Nvidia, Amazon, and Tesla – in the Nasdaq 100 index will be reduced from 50.9% to 40% on July 21 in order to comply with industry-wide fund-concentration limits. This move comes after a surge in the share prices of these tech mega-caps resulted in their combined weighting exceeding limits set by the Securities and Exchange Commission.

Given the Nasdaq 100’s market capitalisation of $17.9tn and its inclusion in 14 ETFs with total assets of over $280bn, potential market disturbances were expected. However, the market has reacted calmly so far.

Concerns have been raised about the possibility of passive ETF investors being “front run” by more agile active investors, but there is no evidence of this occurring at present.

At the close on July 21, ETFs will be required to sell $30bn worth of stocks from the six companies and invest the proceeds in the 94 other companies within the index. This rebalance has sparked worries of ETFs selling stocks that have decreased in value and purchasing those that have risen, but there is no evidence of this happening thus far.

Historically, index-tracking funds have experienced losses of around $3.9bn per year due to predictable, mechanical trading strategies employed during index rebalances. However, this time, the weighted average of the six giants has marginally outperformed the Nasdaq 100 since the rebalance was announced.

Experts suggest that the high liquidity and demand for the stocks being rebalanced make it difficult to successfully trade around the rebalance, reducing the risk of front-running.

Investors remain confident, as QQQ and EQQQ have seen net inflows of over $1.9bn since the rebalance was announced.

While there may be a minor drag on performance due to trading costs, tax implications for ETFs are a concern. ETFs can often avoid capital gains tax liabilities by offloading winning positions “in kind,” but the scale of selling required on July 21 may make this option impractical. Larger ETFs are expected to find opportunities to offload low tax-basis securities and avoid capital gains distributions, while smaller ETFs and mutual fund investors may face tax bills.