ETF investors want low expenses and diversification. The standard play for millions of people saving for retirement is an S&P 500 Index fund, but there are other broad approaches that have performed better than that benchmark.
The wildly successful Invesco QQQ Trust is one of the best. And if you are afraid that valuations of the biggest tech stocks are way too high, take comfort — they are much lower than they were before the dot-com bubble burst in 2000.
Different index-fund approaches
The S&P 500 SPX, +0.69% is the index that dominates the ETF industry. The SPDR S&P 500 ETF Trust SPY, +0.66% tracks this benchmark and has $256 billion in assets. So does the Vanguard S&P 500 ETF VOO, +0.68% which has $102 billion in assets. SPY was established in January 1993, while VOO was established in September 2010.
The Invesco QQQ Trust QQQ, +0.75% hit its 20-year anniversary earlier this week and now has $67 billion in assets. The ETF’s portfolio weighting matches the Nasdaq-100 Index NDX, +0.77%
Here’s how QQQ’s performance over the past 20 years has compared with that of SPY:
FactSet
You can see the tech bubble-and-bursting action for QQQ in 2000. But over the past 20 years, QQQ has greatly outperformed SPY. Here are average annual returns for both ETFs over various periods through March 12:
ETF 3 Years 5 Years 10 Years 15 Years 20 Years Invesco QQQ Trust 19.3% 15.3% 21.1% 12.2% 7.1% SPDR S&P 500 ETF Trust 13.5% 10.5% 16.3% 8.4% 5.9% Source: FactSet An evolving index
The Nasdaq-100 Index includes the 100 largest companies listed on the Nasdaq exchange and included in the Nasdaq Composite Index COMP, +0.69% excluding financial companies.
It is typical for the news media to refer to the Nasdaq Index as the “tech-heavy Nasdaq,” but that term may be misleading, or maybe the term “tech stock” is obsolete.
During an interview on March 12, John Frank, Invesco’s QQQ strategist, pointed out that only one of the FAANG stocks is still considered to be a tech stock.
The FAANG group includes Facebook FB, +0.84% Apple AAPL, +0.44% Amazon AMZN, +1.06% Netflix NFLX, +1.39% and Google holding company Alphabet GOOG, +0.01% GOOGL, +0.15% Those companies make up 16% of the S&P 500 and 45% of QQQ.
S&P Dow Jones Indices includes Facebook, Netflix and Alphabet in the communications-services sector, while Amazon is considered a consumer-discretionary stock. This leaves Apple as the only FAANG still in the information-technology sector.
Then again, just as pretty much every tech company is now a cloud company, it seems that every large company had better be a “tech” company.
So the Nasdaq-100 “is large-cap and closer to mega-cap exposure,” Frank said. “The technology weighting is what people are most surprised about. If you look at the tech weighting over time, it peaked at the end of 2000 at 78%. At the end of 2018 it was 43%,” he said.
Invesco Ltd.
John Frank, QQQ strategist at Invesco.
“How can your company be successful today without using technology? The idea that you can capture innovation [by focusing on particular] sectors is old,” Frank said. “The communications sector, for example, didn’t exist back then. Now it is 20% [of the Nasdaq-100 and QQQ], driven by Facebook and Google, which have taken share of consumer-discretionary spending from IT. And Amazon has increased the consumer-discretionary weighting of the portfolio, also taking away from IT.”
Bubble-like valuations? Think again
You no doubt see headlines in the financial media each day warning that the sky is falling, or that it will do so quite soon. But Frank made an interesting point about valuations of the stocks that dominate the Nasdaq-100 and QQQ: “The largest five companies in the index at the end of 1998 [Microsoft MSFT, +0.77% Cisco Systems CSCO, +0.84% Intel INTC, +1.49% Oracle ORCL, +0.49% and IBM IBM, +0.20% ] traded for 77 times trailing income. At the end of 2018, the current big five traded for about 22 times trailing earnings.”
Getting back to QQQ’s strong performance over the long term, Frank said many companies held by the ETF “have the advantage of proprietary data that they are able to use to improve service to their customers and increase profitability.”
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