This Was The Winning Trade From The Nasdaq 100’s “Special Rebalance”

Earlier this month, I discussed how the tech-heavy Nasdaq 100 was to undergo a rare “special rebalance”, with changes taking effect today (Monday, July 24th). As a recap: the rebalance addresses overconcentration in the index, and also makes life easier for fund managers linked or benchmarked to the Nasdaq 100, helping them stay in compliance with a Securities and Exchange Commission (SEC) diversification rule. Specifically, it’s the rule that limits the aggregate weight of the biggest stock holdings – i.e. those with a 5% representation or greater – to just 50%.

Well, the changes went live today, with the combined weighting of the index’s six biggest tech firms (Microsoft, Apple, Alphabet, Nvidia, Amazon, and Tesla) dropping to 40%, from the 51% they reached at the close of trading on July 7th, when the rebalance was announced. The specific weight changes are:

• Microsoft (9.8%, down from 12.74%)
• Apple (11.5%, from 12.06%)
• Alphabet (5.7%, from 7.61%)
• Nvidia (4.3%, from 7.28%)
• Amazon (5.3%, from 6.91%)
• Tesla (3.4%, from 4.44%)

In my earlier piece, I discussed how the rebalance could present you with a short-term investment opportunity. After all, portfolios that are benchmarked to the Nasdaq 100 and funds that track the index were forced to adjust their holdings to reflect the new weights, which you’d expect to lead to downward price pressure on the stocks whose weights are being reduced while pushing up the prices of the stocks whose weights are being increased. The Financial Times estimated that, based on current market prices, ETFs tracking the index were forced to sell $30 billion worth of stock in the six companies and plow the proceeds into the remaining 94 companies that saw their weighting increase.

So, as I mentioned a couple of weeks ago, the easiest way to profit from this short-term investment opportunity was to buy the First Trust Nasdaq-100 Equal Weighted Index Fund (ticker: QQEW; expense ratio: 0.58%) and short the Invesco QQQ ETF (QQQ; 0.20%). The graph above shows how the trade would’ve performed had you implemented the trades the day the article went live (July 14th) and exited on Friday (July 21st). The QQEW (white line) is up by 1% while the QQQ (blue line) is down by 1%, netting you a 2% return. That might seem small, but 2% in a single week represents 180% on an annualized basis.

More broadly, the performance of this trade suggests that front-running index rebalances can still serve up some profitable short-term investment opportunities. And it makes sense that, according to academic research, US index-tracking funds typically lose about $3.9 billion a year by using predictable, mechanical trading strategies that are exploited by nimbler market participants during rebalances.