Nasdaq 100 is set for special rebalance to reduce overconcentration

Key points in this equity note:

• The US stock exchange Nasdaq will implement a special rebalance of its Nasdaq-100 Index to address overconcentration in the top five securities Microsoft, Apple, Nvidia, Amazon, and Tesla. The special rebalance will be effective before the open on the 24 July 2023.
  
  
• There are 24 ETFs tracking the Nasdaq-100 Index with a combined AUM of $271bn. Assuming the combined index weight in the five largest securities is reduced to 40% this will cause a rebalancing of $9.6bn in those ETFs.
  
  
• Based on benchmark models for transaction cost analysis, the price impact should theoretically be small with the least price impact expected in Tesla shares and the largest impact in Microsoft shares.

A special rebalance to address overconcentration

On Friday, the US stock exchange Nasdaq announced that the Nasdaq-100 Index will undergo a special rebalance effective prior to the market open on Monday the 24 July 2023. The aim is to address overconcentration in the index by redistributing the weights and the special rebalancing will not result in removal or addition of any securities. Nasdaq refers to the methodology paper of the Nasdaq-100 Index for its decision. It says clearly on page 4 that in the event that the five largest securities in the index, with individual weights exceeding 4.5%, have a combined weight above 40% the five largest stocks will be brought down to a combined weight to 40% in the quarterly weight adjustment. In the annual weight adjustment the combined weight would be set to 38.5%.

The special rebalance will be based on shares outstanding as of 3 July 2023 and the index share announcement and pro-forma file release of the weight changes will take place on Friday the 14 July 2023 allowing market participants five trading sessions to meet the new target weights.

Rebalancing should not theoretically not have an impact

As with stock splits and dividends these events do not change the underlying equity valuation of the securities and thus new stories yesterday suggesting the top five technology stocks in the Nasdaq-100 Index were down due to the announcement is a bit silly. Given the underlying value has not changed any front-selling of shares in advance of the special rebalance should theoretically be met by bids as the underlying value has not changed. Despite this obvious fact one could still make the case that forced selling by passive ETFs tracking the Nasdaq-100 Index could move the market.

The table below shows the 8 largest securities in the Nasdaq-100 Index as of 3 July 2023 with the top five securities being Microsoft, Apple, Nvidia, Amazon, and Tesla. These five securities had a combined index weight of 43.55% on 3 July 2023 and thus were in violation with the index methodology at the time of the quarterly rebalancing.

The combined asset under management in ETFs listed in the US and Western Europe tracking the Nasdaq-100 Index is $271bn with the Invesco QQQ Trust Series 1 ETF (QQQ:xnas) being the largest fund with $202bn in assets. As the table below shows the new target weights, assuming the top five securities will be limited to 40% index weight, will lead to estimated $9.6bn in rebalancing value among the 24 ETFs tracking the Nasdaq-100 Index. Based on the past 20-day average daily traded value and a smooth rebalancing over five trading session the volume participation from these ETFs is expected to be maximum 6.67% in Microsoft shares and minimum 0.5% in Tesla shares.

Using the benchmark model for estimating transaction costs we can see that rebalancing Microsoft shares over five trading days would cost the Invesco QQQ Trust Series 1 ETF, the largest ETF tracking Nasdaq-100, approximately 33 basis points in trade costs and multiplying by the index weight the cost would be around 3.5 basis points for this ETF. Rebalancing Amazon and Tesla shares will be no problem for these ETFs. Overall, we estimate low impact from the special rebalance.