What does the Nasdaq 100 rebalancing mean for investors?

Much of the volatility associated with the pending special rebalancing of the Nasdaq 100 has already occurred, suggests a portfolio manager.

“I think the volatility that was going to happen happened last Monday, when you saw some selling pressure in some of the biggest names,” said Robert Cavallo, who co-manages the RBC Global Technology Fund and RBC Life Science and Technology Fund. “I think it’s very short-term noise.”

The Nasdaq 100 is rebalancing on July 24 to address the outsized weighting of the index’s top names, also known as the “magnificent seven”: Microsoft Corp., Apple Inc., Nvidia Corp. Amazon.com Inc., Meta Platforms Inc., Tesla Inc. and Alphabet Inc.

Previous special rebalancings of the Nasdaq 100, which occurred in 1998 and 2011, did not create outsized volatility, Cavallo said.

Further, while index funds that track the Nasdaq 100 will be forced to adjust their weightings, actively managed funds may not have to make as many changes.

For example, Cavallo said his two funds are always structurally underweight Microsoft (12.67% of the Nasdaq 100 before the rebalancing) and Apple (12.04%) because they have a single-security cap of 10%. (Neither of his funds uses the Nasdaq 100 as its benchmark.)

“For a lot of funds, those are weights that were not really ownable anyway, so I don’t know if [the rebalancing] is really going to change the picture for a lot of people,” he said. “I know from our perspective, it’s not going to impact our thesis to own or not own these names.”

Cavallo likes the magnificent seven except Tesla, despite its dominance in electric vehicles. “Our position is that we can’t get comfortable with what’s being discounted in the future in today’s price,” he said. “We still think the risk-reward is not favourable.”

On the other hand, he’s bullish on Nvidia.

“The stock is cheaper today than it was earlier in the year, and what the market is still underappreciating is that the tailwinds from generative AI are going to play out over a longer period,” he said. “Nvidia is still in a very good place of where the numbers are going to settle out over the next year or two.”

When investing in tech, Cavallo said people can make the mistake of expecting losing firms to catch up to winners.

“One thing we find with tech is that it’s not necessarily reversion to the mean — it’s repulsion to the mean,” he said. “From a longer-term perspective, winners win.”

For this reason, he avoids value names in the technology sector. “Turnarounds are really difficult in tech,” he said, explaining that when a company misses a product cycle, restoring their competitive position becomes extra challenging.

For example, Intel Corp. used to lead the semiconductor market due to its design and manufacturing prowess. “But TSMC passed them, and it’s been years and years of trying to catch up,” he said.

Within the semiconductor space, Cavallo also likes Cadence Design Systems Inc. and Synopsys (both based in California), which he said have essentially an oligopoly on designing semiconductors.

The Nasdaq 100 reconstitutes each December, but must also rebalance whenever the stocks that individually constitute more than 4.5% of the index add up to more than 48%. (The percentage must be brought down to 40%.) The magnificent seven currently constitute more than 55% of the Nasdaq 100.

For the year to July 14, the Nasdaq 100 returned 43.4%, while the S&P 500 returned 17.8%.

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.