Whatever theories are being proffered as to why index overseers chose to cap the influence of technology megacaps in the Nasdaq 100, the real reason is a simple one.
The special rebalance, the first ever of its kind, is intended to prevent fund managers linked or benchmarked to the index from violating a Securities and Exchange Commission diversification rule. Specifically, it’s one that limits the aggregate weight of the largest stock holdings — those with a 5% representation or greater — to 50%, according to Cameron Lilja, vice president and global head of index product and operations at Nasdaq.
“This methodology rule is in place to ensure that any funds that are tracking the Nasdaq 100 remain in compliance with the Regulated Investment Company diversification rule,” he said in an interview.
The comment sheds light on the unprecedented action, which focused attention on huge gains this year by firms such as Apple Inc. and Microsoft Corp. While it’s tempting to frame the rebalance as a response to warnings the narrowness of the rally somehow doomed its future, the truth was a bit more clinical.
“From our perspective, the motivation to reduce index concentration is purely from the regulatory angle,” Lilja said.
The rebalance, scheduled to take effect July 24, is expected to reduce the influence of six tech giants — Microsoft, Apple, Alphabet Inc., Nvidia Corp., Amazon.com Inc., and Tesla Inc., while boosting the presence of other members in the Nasdaq 100.
While details on the action won’t be announced until later this week, a paper on the Nasdaq website says special rebalancings can be called when the portion represented by the index’s biggest members exceeds a preset threshold. In one scenario, the document says, weights can be pared back if the combined influence of the largest companies — those making up 4.5% or more of the gauge — adds up to more than 48%.
Data compiled by Bloomberg show that was the case on July 3, when the six companies saw their combined weight reach 50.9%. The Nasdaq methodology paper suggests a rebalancing may be enacted to reduce the group’s influence to 40%.
Companies set to benefit from the rebalance include Starbucks Corp., Mondelez International Inc. and Booking Holdings Inc., according to an analysis from Wells Fargo & Co. strategists including Chris Harvey.
The revision means index-tracking funds such as Invesco QQQ Trust (ticker QQQ) need to tweak holdings. While that presents a headwind for tech megacaps in the near term, the event won’t pose a lasting threat, Harvey and his colleagues wrote in a note.
“We believe this liquidity event dents — but does not break — the longer-term uber-cap trend,” they said.
The rebalance is a consequence of the unstoppable rally in the six tech firms, an advance that’s mostly fueled by optimism over artificial intelligence. Their shares have advanced 62% on average year-to-date, almost three times as large as the average stock in the Nasdaq 100.
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