What a Mess: Nasdaq 100 Rebalancing Leads to Wacky Weightings

Why is Qualcomm No. 4 instead of No. 9? On the Nasdaq 100, last year's index change meant to clear up problems has created new ones.
Publish date:

There are worse things you could have done than resolved to put your money in the

Nasdaq 100

last January. Only about one in 20 domestic equity funds can top its 58% return this year. And most individual stocks are actually


on the year.

But the index itself is a mess.

When the Nasdaq 100 was rebalanced last December, the aggregate weight of the five largest stocks in it was scaled down to 40% from about 60%. Other components' weightings were raised in turn. The idea behind this, according to the

Nasdaq Stock Market

, was to "provide enhanced diversification of the underlying securities basket and result in a better representation" of the Nasdaq as a whole. And so it did.

Market movement over the past year, however, has seriously skewed the index. Some of the big stocks stalled out, while some smaller stocks saw significant gains. An obvious example is


(QCOM) - Get Report

, whose gain of around 1,300% since the rebalancing has made it the fourth-largest component in the index. Problem is, on a market-capitalization basis, it only rings in at ninth.

MCI WorldCom


, the No. 5 stock in the index, has a market cap that's nearly 3 times as high.

And Qualcomm is just one example of many.

Sources: Nasdaq; Baseline. Figures as of Nov. 16, 1999.

Arguably, the index is no longer such a great representation of the Nasdaq Stock Market and is ripe for a rebalancing. There has even been scattered talk of taking advantage of any changes in the index, shorting things like



, which would go to No. 13 in the index (based on Tuesday's close) from No. 6, and buying things like



, which would go to No. 8 from No. 34.

"There will be adjustments when it's rebalanced," says Leon Gross, options strategist at

Salomon Smith Barney

. About $3.5 billion is invested in


(QQQ) - Get Report

, the depositary index shares launched last spring. More importantly, place in the index packs a psychological wallop -- Gross points to the 17%


(RNWK) - Get Report

gained Tuesday on word that it would be added to the Nasdaq 100. A rebalancing could roil the market.

But Nasdaq has no plans to change the index just yet.

"The Nasdaq 100 is an index," says Pete Canada, assistant director of trading and market services at Nasdaq, who helped oversee the rebalancing last year. "But vis-a-vis the depositary shares, it's also a portfolio of securities." Nasdaq, he says, has a responsibility to those investors.

"When you change the weight of one, you have to change the weight of all of them," says Canada. "The implication would be a massive program trade of 100 securities."

But eventually Nasdaq is going to have to pay the piper. When announcing its rebalancing last year, it said that it will adjust the weightings of the index after its quarterly review whenever:

(1) Any individual component's securities represent more than 24% of the total market value of the index; and/or (2) The combined weight of all securities having individual weightings of at least 4.5% exceeds 48% of the total market value of the index. Once the index has been initially adjusted, it will be subsequently readjusted only if the index weights exceed the 24% and/or 48% thresholds.

While neither of those things looks like it's going to happen when the index gets reviewed next month, it seems almost inevitable that they someday will. And it will be a bloody mess.