QQQE: Tech Exposure Without Overweighting The Magnificent Seven

Tech and growth have significantly outperformed since the financial crisis, due to rising earnings and valuations. The Magnificent Seven mega-cap growth stocks have performed even better, been responsible for most of the S&P 500 gains since early 2023. These gains have caused valuations to spike, with most Magnificent Seven companies sporting P/E ratios above 30.0x, some higher than 50.0x. Some investors want tech or growth exposure, but are put off by these companies and their valuations. For these, the Direxion NASDAQ-100 Equal Weighted Index Shares ETF (NASDAQ:NASDAQ:QQQE) might be an interesting choice.

QQQE is an equal-weighted Nasdaq-100 index ETF. It offers investors diversified equity exposure, with a significant tech and growth tilt. Importantly, QQQE’s weighting scheme significantly reduces the fund’s exposure to mega-cap tech stocks, including Microsoft (MSFT) and Nvidia (NVDA), relative to broader equity indexes, including the S&P 500 and the Nasdaq-100. Doing so means fund performance is less dependent on the performance of a couple of stocks, some of which look overvalued.

In my opinion, QQQE’s diversified holdings and reduced mega-cap tech exposure make the fund a buy. The fund also looks particularly interesting for tech and growth investors somewhat concerned about valuations in the largest companies in this space.

QQQE – Overview and Analysis

QQQE is an equal-weighted Nasdaq-100 index ETF. Let’s have a look at the index before tackling the fund itself.

The Nasdaq-100 is an equity index including the 100 largest domestic and international non-financial companies listed on the Nasdaq Stock Market. As with most indexes, applicable stocks must also meet a basic set of inclusion and exclusion criteria, but these are quite lax. The Nasdaq-100 is tilted towards larger companies, which themselves tilt towards tech and growth. It does exclude financials, as well as several important, well-known large-caps including Johnson & Johnson (JNJ) and Coca-Cola (KO).

QQQE itself tracks the Nasdaq-100 index, but equal-weights the holdings. In the index, mega-cap tech stocks like Microsoft and Apple (AAPL) have the exact same weight as smaller index members like Illumina (ILMN) and Dollar Tree (DLTR). The result is a moderately diversified large-cap equity fund, with investments in 100 companies, and exposure to several industry segments. It tilts tech and growth, but less than the Nasdaq-100 index itself. Compare industry weights for the QQQE with the Invesco QQQ Trust ETF (QQQ).

QQQE is technically a global fund, as the Nasdaq-100 does not exclude international stocks. In practice, it is a U.S. fund, as said index includes very few international stocks.

Overall, QQQE seems moderately diversified, although materially less than the broader U.S. equity indexes, including the S&P 500. QQQE simply lacks sizable exposure to several industries, including financials, materials, and real estate, and investments in many large-cap stocks, to be as diversified as said index.

QQQE is overweight tech, which impacts the fund’s performance, especially its relative performance to the S&P 500. The fund tends to outperform when tech outperforms, as was the case in 2023. QQQE did trail behind the Nasdaq-100 index, however.

On the flipside, the fund tends to underperform when tech underperforms, as was the case in 2022. QQQE did outperform relative to the Nasdaq-100 index, however.

To summarize, QQQE is an equal-weighted Nasdaq-100 index ETF, with investments in 100 large-cap equities, and with a significant overweight position in tech.

QQQE – Performance Analysis

QQQE’s performance track-record is quite strong, with the fund generally posting double-digit annual returns, and outperforming the S&P 500 since inception, and for most time periods.

Some further comments on the above…

Returns look quite weak on the 3Y mark due to sizable losses during 2022, and partly due to timing/sequence of returns. Returns look stronger on both shorter and longer-term time periods.

QQQE has tended to underperform the Nasdaq-100 since inception, but a significant portion of said underperformance happened last year, during which just seven stocks drove stock market returns.

QQQE somewhat performs as a cross between the Nasdaq-100 and S&P 500. This is because the fund’s tech exposure is between that of these two indexes.

Overall, QQQE’s performance seems reasonable enough. The fund has outperformed the S&P 500 since inception, and although the Nasdaq-100 has outperformed by more still, this is a recent phenomenon.

QQQE – Valuation Analysis

QQQE is significantly overvalued tech, one of the most expensive industries right now. Due to this, the fund trades at a sizable premium to the S&P 500. It does trade at a small discount to the Nasdaq-100 index itself, due to underweighting some of the more expensive mega-cap tech stocks, including Tesla and Nvidia.

QQQE’s more expensive valuation is a significant negative for the fund and its shareholders, and could lead to losses if valuations were to normalize or sentiment to worsen. This was last the case in 2022, but sentiment has much improved since then.

QQQE vs. QQQ

QQQE’s biggest differentiator is the fund’s equal-weighted holdings. These provide investors with significantly greater exposure to smaller companies than more traditional market-cap weighted funds, and with comparatively lower exposure to a small number of mega-cap stocks. Doing so benefits investors in two key ways.

First, lower exposure to mega-cap stocks means that performance is less dependent on the performance of a small number of stocks, reducing idiosyncratic risk and portfolio volatility. Right now, the Nasdaq-100 holds a 9% position in Apple and Microsoft each. Although neither position is excessive, investors could see single-digit losses from double-digit losses in either. QQQE holds a 1% position in each of these, and so would barely be impacted by double-digit losses in either company.

In practice, these and other mega-cap stocks have performed exceedingly well in the past, so underweighting them has decreased long-term returns with no measurable impact on risk or volatility. Still, I do believe that QQQE’s more balanced portfolio is the less risky choice, even though this has not been the case in the past.

Second benefit of increasing exposure to smaller companies, is the fact that these should outperform larger companies long-term, due to greater growth prospects. Tesla is a fantastic example of this. The company got added to the Nasdaq-100 index over a decade ago. Tesla was a comparatively small company at the time, with a tiny weight in the index itself. The Nasdaq-100 benefited from Tesla’s meteoric rise throughout the years, but gains were limited due to its tiny weight. QQQE invested a bit more in Tesla at first and saw benefited a bit more from these gains.

Once Tesla became one of the largest companies in the world, its weight in the index rose, but performance has been spottier since. Because of issues with timing and dates, it is impossible for me to quantify these issues, but I looked at these issues for the S&P 500 a few years back and came to the same conclusion. Early investments in companies like Tesla are immensely profitable, and QQQE is better in that regard than the Nasdaq-100 index itself.

Considering these issues, I think that QQQE is a strong investment opportunity, and a bit stronger than market-cap weighted index funds on the Nasdaq-100.

Conclusion

In my opinion, QQQE’s diversified holdings and reduced mega-cap tech exposure make the fund a buy.