Investing In The Nasdaq

Investing in the Nasdaq

The Nasdaq exchange has been pretty much synonymous with innovation since its founding 50 years ago. It was the world’s first electronic stock market and its innovative approach to trading – plus the fact that it had some of the lowest market listing fees available – made it the go-to home for young growth companies that wanted to raise funds by offering their shares to the public. Many of those companies were – and still are – bred from the technology industry, which is why today’s Nasdaq is heavily populated with firms from that sector.

Along with being an exchange for trading securities, Nasdaq publishes two indexes: the Nasdaq Composite and Nasdaq 100. Both are size (or market capitalization) weighted indexes of companies trading on the exchange. Basically: an index is a listing of firms, and a size-weighted index shows each firm’s contribution to that index, with the biggest members making up the largest percentages of the index. The Composite is formed from the shares of nearly all – more than 3,700 – firms that trade on the exchange. This is cut down to the 100 biggest members of the exchange for the Nasdaq 100.

America’s Big Tech goliaths dominate both indexes. Apple and Microsoft make up nearly 25% of both the 100 the Composite. Because of this, and the fact that the 3,600 or so other firms that aren’t in the 100 are pretty small, the total market value of the Nasdaq 100 is around 80% of the Composite.

Why invest in the Nasdaq?

Most of today’s hot investment themes – artificial intelligence (AI) being the current headline-grabber – are being cultivated inside the technology industry, making Nasdaq-listed firms a natural hunting ground for investors who want exposure to those themes. What’s more, the Big Tech firms that dominate the index have their fingers in most, if not all of the exciting thematic pies. So while the index itself is relatively concentrated among the big guys, Nasdaq index investors are at least getting some diversified exposure to all the exciting stuff going on. Investing in the Nasdaq indexes, then, should mean your portfolio’s exposed to firms that have the potential to grow faster than the overall economy.

How do you invest in the Nasdaq?

People who want to invest in the Nasdaq indexes have three main options.

First, they could buy shares directly in the individual companies within the index. To recreate the entire index, though, would be an arduous task and might result in transaction costs. There’s also the headache of monitoring the index to ensure your portfolio’s weightings stay in lockstep with its composition. See, as prices move around, the market values – and therefore the weightings – of index members change. One way around this is to hand-pick a selection of stocks from the indexes – say, the top 10 biggest firms. But that strategy comes with the risk of being overly concentrated, meaning your performance will be determined by a relatively small number of companies. And that’s generally not a very good idea.

Second, they could buy an exchange-traded fund (ETF) designed to replicate the index. The fund providers construct and constantly manage the portfolios to ensure they look identical to the underlying indexes. There’s a cost to doing that, though, and so ETF providers charge a management fee. Luckily (for investors anyway), intense competition in the market has driven those fees down, and investors can expect to pay somewhere between 0.05% and 0.75% a year.

ETFs trade like shares on a stock exchange, so investors can buy or sell during market hours. Those that track the Nasdaq 100 are more popular than the ones that track the Composite. The iShares Nasdaq 100 UCITS ETF is one of the leading ETFs. It charges 0.33% a year and trades primarily on the London Stock Exchange. There are other Nasdaq 100 ETF providers, like Invesco or Xtrackers (a brand of DWS), so investors should check out which exchange they trade on, and the fees they charge. It’s also a good idea to buy ETFs from reputable firms, and look to see if they’ve attracted a lot of other investors’ cash. ETFs with a lot of assets under management (AUM) from famous reputable firms like iShares (a BlackRock product) should provide investors with peace of mind. The bigger ETFs also tend to charge smaller management fees too.

The Invesco QQQ Nasdaq 100 ETF is the most popular option on the market. It trades on the Nasdaq exchange so UK-based investors need to check the requirements for investing in foreign securities. It’s attracted more than $200bn in investor funds and charges a relatively small 0.2% annual fee.

Third, investors could choose a firm that employs professional fund managers to actively manage people’s money. To get Nasdaq-like exposure, though, they’d have to opt for a fund whose managers invest specifically in technology, or other growth-oriented sectors. These funds work like ETFs in that they pool investments together and issue shares or units to investors. The manager of the fund invests the pooled cash by constructing a portfolio that will look different from an index like the Nasdaq, but with the intention of outperforming that index.

Unfortunately, most active managers don’t actually outperform the very indexes they’re targeting, which is why there’s been such an explosion of popularity in the “passively” managed ETF sector.

There is a fourth option too. The Nasdaq itself is publicly listed, and investors could buy shares directly in the firm. There’s no underlying exposure to other tech firms, but Nasdaq makes its money by selling its index data to the companies that create and manage ETFs and funds. Nasdaq also makes revenue from transaction fees when investors buy and sell shares listed on its exchanges. In a sense, then, investing in Nasdaq’s shares is an indirect way for investors to get exposure to the technology sector, its themes, and investors’ appetites for them.

What are the potential downfalls of investing in the Nasdaq?

There are a number of risks worth pondering before plumping for one of the routes to Nasdaq index investing. First, because the index is very technology-heavy – more than 50% of the Nasdaq 100 is made up of tech firms – investors don’t get the broader exposure on offer with other main US stock indexes. The S&P 500 is loaded with technology firms too, of course, but it is more diversified, with higher exposure to the healthcare, industrials, and energy sectors than Nasdaq indexes offer. The Nasdaq’s concentration also means it tends to be more volatile than the broader S&P 500 and experiences bigger daily price swings.

Probably the heftiest risk with a technology-focused strategy overall, though, is that the sector can go out of fashion. There are various reasons for this, but more often than not it coincides with excessive valuations. Lofty prices tend to arise when investors become overly ambitious about the prospects of tech firms, bidding up their share prices to unsustainable levels. Last year was brutal for tech investors, as central banks pushed up interest rates in an effort to kill inflation. Those higher rates disproportionately hurt tech and other growth stocks, but the rout was as much a result of 2021’s rich tech valuations as it was about higher interest rates. In any case, 2022 served as a reminder to investors that a tech-focused portfolio does come with fairly substantial risks.