Summary
- The NASDAQ-100 is one of the historically best-performing indexes.
- Exceptional historical returns have been unmarred by illogical asset selection processes.
- Significant volatility could expose short-term investors to unwanted levels of risk.
- Heavy U.S. & tech-centric holdings provide little diversification for potential investors.
- Fantastic performances still suggest QQQ could be a useful side-piece in the building of a portfolio.
Investment Thesis
The Invesco QQQ Trust ETF ( QQQ ) is one of the most historically best performing ETFs, period.
It's unrivalled levels of investor returns have rightfully made it the second most heavily traded (by volume) ETF only playing second fiddle to the ever popular S&P 500 tracking SPDR S&P 500 ETF Trust ( SPY ).
However, when analyzing the fundamental characteristics of the fund using The Value Corner's professionally developed ETF Analysis Structure, it is clear to see that some aspects of the fund's processes are less than logical.
Therefore, a deep-dive into how the fund operates, who is running it and what investors could potentially expect to see moving forwards is necessary to evaluate the applicability of the fund in today's economic situation.
TVC's ETF Analysis Structure
Below is an explanation of our professionally developed ETF Analysis Structure. For each metric an ETF can be awarded up to five stars, five representing a 'good' score, one representing a 'poor' score.
The final score assigned to each firm is an aggregate of the number of stars earned in each category divided by the maximum possible score, multiplied by 100 and expressed as a percentage.
Fund Objective - ***
The Invesco QQQ Trust ETF is a Unit Investment Trust which aims to track the performance of the NASDAQ-100 companies. The firms included in the fund's holdings are the 100 largest non-financial companies listed on the NASDAQ exchange. The fund currently has over $161B Assets Under Management ((AUM)).
The primary objective is to offer investors a passively managed ETF with direct exposure to only companies which fall into the narrow category mentioned above. The asset class structure is focused (around 50.45% of all holdings) on technology stocks.
This delivers investors with high levels of exposure towards companies that are focused on innovation and new technologies. Most of these companies would be commonly classified as U.S. Large Cap Equity stocks.
Exposure to the largest single equity held by the firm is currently (20/02/2023/) Apple which rests at a 12.21% allocation as a portion of total fund worth.
Due to the heavy weighting of the top 10 holdings and focus on a historically volatile market segment, QQQ tends to exhibit greater levels of volatility than most large-cap equity ETFs.
The fund's complete ignorance of the financial sector acts to further differentiates it's habitual tendencies from other more broad, large and mega-cap ETFs.
The fund's core objective is well defined and transparent, but arguably a little illogical from an investment standpoint. This earns the fund's objective a THREE STAR rating in our analysis structure.
Asset Selection Process ((ASP)) - **
The fund is a modified market capitalization-weighted index of securities issued by 100 of the largest non-financial companies listed on the Nasdaq Global Select Market or Nasdaq Global Market.
Equity holdings within the fund are weighted according to their market capitalization . Both international and domestic companies are present within the fund, with the only key criterium being market cap and being listed on the NASDAQ exchange.
Certain regulatory requirements force Invesco to ensure that the current weight of the single largest market capitalization holding cannot be greater than 24.0% .
Invesco must also ensure that the collective weight of those holdings whose individual current weights are in excess of 4.5%, when added together, do not exceed 48.0% of the total Index.
The fund is rebalanced quarterly to ensure the base ASP criterium along with the regulatory criteria are being met to ensure the index accurately reflects the NASDAQ-100.
Invesco QQQ Fact Sheet
Investors into the fund will be subject to an almost entirely US-focused fund with 97.81% of holdings (classified by NAV) being geographically located in the US. China represents the second large exposure at a negligible 0.98%.
Invesco QQQ fact Sheet
From a sector perspective, 50.45% of the fund's portfolio by NAV is composed of Information Technology stocks with Communication Services coming in second at 16.17%. Consumer discretionary also represents a sizeable 15.75%.
The primary fault we see with the ASP present in the QQQ fund lies with the requirement for companies to be listed on the NASDAQ exchange.
While this requirement makes absolute commercial sense for NASDAQ as it promotes the popularity of their exchange, it makes very little sense from an investment research and analytical perspective.
We find assessing the inclusion of holdings based on their market capitalization is an acceptable means of discrimination, particularly if the goal is to have a fund focused on large-cap growth and value stocks.
While QQQ engages in almost direct weighting based on market cap, other large-cap growth oriented funds such as Vanguard's Growth ETF ( VUG ) employ a more complicated, composite-based selection process.
Such composite selection metrics can consider a variety of factors such as growth and valuation metrics to refine their asset selection process even further.
Furthermore, many other ETFs which rival QQQ both in holdings classifications and expected returns have significantly more total holdings (for example, VUG has over 250 ) thus increasing the exposure to the desired market segments or demographics.
QQQ's 100 holding limit is once more an illogical application of commercial motivations against sound economic reasoning. The potential issue with limiting the number of holdings in the fund comes from the risks associated with increasing ones exposure to only a handful of companies.
While historic returns are attractive (QQQ's 10Y returns hover around 20% per annum), this significant performance does not resolve the economic irregularities present in the funds ASP.
More attractive alternatives have begun to surface in recent years all with the aim of replicating QQQ's focus on tech-companies and large-cap growth stocks while simultaneously ensuring a slightly more diverse overall portfolio.
Overall, the fund has what The Value Corner deems as flawed ASP methodology. This is largely due to the undermining of logically sound selection criteria by commercially motivated factors. These factors cumulate in QQQ earning just TWO STARS for The Value Corner's ASP metric.
ETF Provider - ****
Invesco Home Page
This fund is provided to the investor by Invesco. Invesco is one of the largest independent investment management firms. The company has been managing ETF's for 15 years and are continuing to innovate within the sector.
With a mix of fixed income, equity and alternative ETFs, Invesco has a wide-spread range of offerings to suit almost any portfolio strategy. Most of their primary ETFs focus on well-known market indexes.
The company is devoted to providing full transparency to investors with regards to their processes and fund management methods. Significant efforts have been made by the company to include KIID documents with many of their more popular ETFs to ensure investment is possible outside of the U.S.
With over $1.4T in AUM, the company is a surefooted powerhouse in the ETF space. While some of their ETF offerings have showed slightly weaker performances than desired, it would be unfair to critique them for offering what investors clearly demand, regardless of performance.
Only the Vanguard Group comes to mind as having a better corporate structure, thanks to the investor ownership structure present at the firm. Therefore, Invesco receives a FOUR STAR Provider rating from The Value Corner.
Management Team - ****
Invesco boasts an incredibly skilled management team who are supported by over 800 investment professionals. All of Invesco's fund managers are highly experienced individuals who collectively contribute a large amount to their ETF projects.
Invesco discloses that all employees (including investment managers) receive renumeration bonuses for work which exceeds internal performance comparisons, external market comparisons, and formulaic portions of incentive plans. This ensures the interest of managers, and their clients remain aligned and promotes employee motivation.
This fund has two Managing Directors : Jordan Krugman and John M. Zerr. Final oversight is provided by Anna Paglia who is the Managing Director and Global Head of ETFs.
Combined, these individuals bring excellent knowledge, industry experience and guidance to the fund both with regards to its overall strategy and day-to-day operations. The management quality at Invesco seems to be as good as one could hope to see.
Thanks to the great experience and managerial proficiency found at this fund, I assign the management team with a FOUR STAR rating.
Expenses & Fees - ****
Investors in QQQ enjoy low annual fund operating expenses. These expenses are paid each year by the investor as a percentage of the value of their investment.
Total annual expenses to the investor amount to just 0.20% of total investment value. This represents a -51.3% difference to the median of all ETF's (0.39%). In general, we believe any total expense ratio under 1.5% could be considered by as being satisfactory.
It comes as no surprise that Seeking Alpha's quant has provided a " B+ " expense grade which I would have no issue promoting to an "A" status. While the expense rate is higher than some funds such as Vanguard Total World Ex-US ( VXUS ) which has a minute 0.07% expense ratio, 0.2% is still fantastic compared to some ETF offerings.
A total expense ratio of 0.2% is an entirely acceptable and warranted given the high quality nature of the funds management team. This earns QQQ an Expenses & Fees rating of FOUR STARS.
Performance Metrics - *****
Quite simply, the fund has seen truly remarkable results for much of the past 10 years. In this time period, the fund has managed 17.05% annualized returns. This beats the incredibly popular SPDR S&P 500 ( SPY ) index by over 4.47 percentage points.
Most of this performance can be attributed to the excellent past decade technology and communications stocks have enjoyed. The meteoric rise and subsequent sky-high valuation for companies such as Amazon helped propel the index into new heights.
The less stringent and more simplistic ASP for QQQ also helps to quickly include new growth companies in the fund's portfolio such as Tesla back in 2019-2021. This provides a further boost to annual returns, particularly when high market evaluations prevail in a market.
However, the tech-heavy growth-oriented nature of QQQ also exposes it to significant volatility. According to research conducted by Portfolio Labs , QQQ has an average 6-month volatility of 22.80%, 7% points greater than SPY's 15.23%.
While short-term gains can be tremendous, the index is susceptible to significant drawdowns in periods of economic decline. QQQ has seen 30 year maximum drawdown depths (expressed in % value) of -81% while indexes such as the S&P 500 have seen 50.8% as absolute maximums.
Nonetheless, the QQQ's undeniably attractive performances over the past 30 years make it a fantastic long-term (circa. 20+ year) pick for long-oriented investors. Shorter-term investments would be much more susceptible to the volatile nature of the fund and could yield poor results.
Thanks to stellar long-term performance, the fund receives FIVE STARS on The Value Corner's performance metric.
Investment Style & Risk - **
In The Value Corner's opinion, QQQ should be classified as an aggressive fund due to its pure focus on stocks listed on the NASDAQ-100 with an industry focus split across just two different sectors.
This is clearly echoed by Seeking Alpha's Quant which has assigned QQQ with a "D" Risk Grade .
The significant weighting towards a handful of non-defensive sectors (due to the market-cap driven ASP) undoubtably increases the volatility of the ETF.
A narrow asset allocation, limited number of equities and regional diversity provide little source of risk diversification for investors. These limitations culminate in the fund experiencing the large drawdowns in unfavorable market conditions.
The QQQ fund currently (12/31/2022) suffers from a high P/E Ratio of 34.20 and a peak CAPE (Cyclically adjusted PE ratio: real EPS averaged over 10 years) of 59.53. These metrics suggest that the holdings within the fund are significantly overvalued.
Consequentially, it could be argued that the fund should decrease in value as the intrinsic components that constitute it's holdings are valued at an excessive premium.
While the large portion of growth stocks that make up the fund are known for harboring sometimes significantly high valuations , it is a risk one must take into account when considering building a position in the fund.
QQQ's almost exclusive exposure to U.S. companies significantly decreases the geographic diversity many investors look for when selecting an ETF. While the U.S. has seen the best stock market returns of any nation for much of the last 30 years, it is always possible that this dominance could shift.
A research whitepaper by The Vanguard Group suggests that the U.S. will see less growth in the upcoming 10 years, seeing international equities outpace their domestic counterparts by 3.4%.
While it is difficult to say what the future holds for U.S. companies, significant uncertainty is present in the market due to the geopolitically active and turbulent environment currently facing our globe.
QQQ's U.S. only focus could therefore be considered both a risk and a potential source of stability, all depending on the growth and prosperity the U.S. will see moving 20 or even 30 years into the future.
Overall, the fund inherits a high level of risk due to its limited geographic and sector diversity. In the short-term, the significant potential for a recession later in 2023 hinders the potential gains the fund could make.
In the long-term, the potential for returns is significantly higher but marred by the almost exclusive exposure the fund has to the overall performance of the U.S. economy.
Due to the aggressive nature of the fund and significant overexposure to certain sectors, the fund earns Two Stars in the Investment Style and Risk metric.
Summary
All the metrics discussed in this analysis leave the Invesco QQQ ETF with a 69% rating from The Value Corner's professionally constructed ETF analysis tool. This qualifies the fund for a chartreuse color coding, falling just shy of the 70% mark required for light green.
The fund provides investors with significant exposure to a limited number of tech-oriented, large-cap growth stocks.
The sometimes economically illogical ASP and high exposure to risk has historically proven to only increase volatility with 30-year average returns being some of the highest for any ETF.
A highly capable management team combined with a sufficiently low expense ratios create an ETF which could be a potentially lucrative side-piece element for many investor's portfolios.
Unfortunately, an uncompromising macroeconomic environment leaves most economies facing economic slowdowns with non-US markets expected to be hit especially hard.
Therefore, while an attractive long-term investment thesis is present, timing an entry into a position in current market conditions is incredibly difficult.
As always, I personally pursue a dollar-cost-averaging approach to building a position particularly in a bear market. Therefore, I will be following the current economic situation keenly moving further into 2023 and will be continuously re-evaluating the motion to begin building a substantial position.
For further details see:
QQQ: A Deep-Dive Into The Fund's Characteristics