Growing Risks of Nasdaq 100 Fund

New York ( TheStreet) -- With $31 billion in assets, PowerShares QQQ ( QQQ) ranks as one of the most popular exchange-traded funds. Lately shareholders have had cause to be pleased. The ETF, which tracks the Nasdaq 100, has returned 17.9% this year, outdoing the S&P 500 by more than 3 percentage points, according to Morningstar.

The long-term returns have also been notable. During the past 10 years, the PowerShares fund returned 10.8% annually, topping the S&P by 4 percentage points and surpassing 99% of large growth competitors.

But after the big rally, there is reason to be wary. The ETF owes much of its stellar showing to Apple ( AAPL), which accounts for 19.7% of the assets. This year Apple shares have returned 49.8%. During the past decade, the stock has returned 54% annually.

Besides Apple, the fund has big positions in a handful of technology giants, including Microsoft ( MSFT), Google ( GOOG) and Oracle ( ORCL). Altogether eight technology stocks account for 52% of the assets. If the technology sector disappoints, then the QQQ fund could sink badly.

Even if you are bullish on technology, the PowerShares fund may not be the best choice. The problem is that the ETF has a peculiar structure, holding 100 of the biggest stocks that trade on Nasdaq. While the S&P 500 is deliberately designed to provide a cross section of the market, the QQQ index focuses on whatever stocks happen to dominate the Nasdaq listings. The benchmark has 63% of assets in technology, and most of the rest are in health care and consumer cyclicals.

There are no energy or financial stocks. As a result, the benchmark does not provide broad market exposure, and it is not a pure play on technology.

Launched in the bull market of the late 1990s, the QQQ fund became an immediate hit because it offered a convenient way to bet on Nasdaq's hottest growth stocks. When the Internet bubble burst in 2000, the fund sank hard.

Today the ETF remains popular with investors who want to place a bullish bet on the market, says Matt Hougan, senior editor of IndexUniverse.com. "When the market is rising, people reach for the QQQs," he says.

The fund often performs well in up markets, Hougan says. But because of its lopsided sector allocations, the ETF will not excel when such sectors as energy lead the rally. Hougan says that instead of using the PowerShares fund, investors should prefer other alternatives. Those who seek to hold technology should consider a pure fund, such as Vanguard Information Technology ( VGT).

Investors who want to place a bullish bet on the broad market might prefer holding Guggenheim S&P 500 Equal Weight ( RSP). The equal-weight fund has assets in every sector and does not emphasize any one stock. In addition, the Guggenheim fund may pack a bit more punch in a rally as indicated by a measure known as beta, which describes an investment's sensitivity to market movements.

The Guggenheim fund has a beta of 1.11. So if the S&P 500 rises by 100, the fund would tend to climb by 111. The PowerShares fund has a beta of 1.08.

Another way to hold the Nasdaq 100 and get some extra juice is with First Trust Nasdaq 100 Equal Weight ( QQEW), which has a beta of 1.16. The fund has about 1% of assets in each of the 100 stocks. When the market soared in 2009, the First Trust fund returned 59.5%, compared to 54.5% for the PowerShares QQQ fund. The First Trust fund can jump higher because it has more weight in volatile, smaller stocks, which tend to spring when markets rebound sharply.

The equal-weight fund has 47% of assets in technology. Because it has a small stake in Apple, the First Trust fund has lagged PowerShares QQQ during the past five years. But if Apple stumbles, the equal-weight fund could move into the lead.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.

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