The Invesco NASDAQ Next Gen 100 Fund (NASDAQ:QQQJ) is a mid-cap growth ETF with strong tech exposure. The fund's holdings generally see strong revenue and earnings growth, which should lead to market-beating returns, at least as long as valuations remain elevated.
QQQJ invests in the 101st to the 200th largest companies on the Nasdaq, which are on the road to joining the more well-known Nasdaq-100 index. Stocks tend to skyrocket in the months prior to their inclusion in a well-known index like the Nasdaq, in anticipation of increased passive investor inflows. Some of QQQJ's holdings are set to join the Nasdaq-100 index in the near future, which should boost returns for the fund moving forward.
QQQJ's strong potential and expected returns make the fund a buy. As the fund focuses on comparatively risky tech growth stocks, it is less appropriate for more risk-averse investors and retirees. With a 0.22% yield and negligible dividend growth, it is simply not an income vehicle of any kind.
QQQJ - Overview
QQQJ is an index ETF administered by Invesco. It tracks the Nasdaq Next Generation 100 Index, a market-cap weighted index of the 101st to the 200st largest companies in the Nasdaq. It explicitly excludes the largest 100 companies in the Nasdaq, which are included in the Invesco QQQ ETF (QQQ) instead.
QQQJ's index and holdings have several important characteristics. As the Nasdaq is quite focused on tech, and as it specifically excludes financial companies, QQQJ is a very tech-heavy fund. Tech accounts for 48% of the value of the fund, ignore the type in the graph below, quite a bit higher than average for an equity index fund. The fund does provide some measure of industry diversification, although less than average when compared to broader equity index funds.
(Source: QQQJ Corporate Website)
(Source: QQQJ Corporate Website)
QQQJ's strong focus on tech means that the fund is much more exposed to the performance of said industry than average. Expect QQQJ to outperform when tech outperforms, and vice versa. As the fund is quite new, less than a year old, we can't really analyze its performance in any meaningful way, but the fund does seem to behave as expected. QQQJ outperformed earlier in the year, when tech was posting strong gains, but stalled starting from March, when tech did likewise. The net result is very slightly underperforming the market.
QQQJ's performance looks much stronger on the backtest, but that is almost always the case for backtests.
QQQJ's tech focus is likely to increase long-term returns, due to the rapid growth of said industry. On the other hand, focusing on tech to the exclusion of other industry segments increases portfolio risk and volatility, especially with valuations as stretched as they are. Significant losses and underperformance is possible.
QQQJ avoids investing in the 100 largest equities in the Nasdaq index. These are generally mega-cap stocks, and so their exclusion results in a more mid-cap focused fund, with comparatively smaller holdings. QQQJ sports a weighted average market cap of $24B, compared to $897B for QQQ and $563B for the S&P 500. Smaller companies tend to be significantly riskier than average, due to undiversified revenue streams, comparatively weak balance sheets, and less proven, sustainable business models. Expect the fund to underperform during downturns and recessions, although the fund is too new for us to actually see how it would performed under said conditions.
QQQJ - Investment Thesis
Fundamentals and Index Mechanics
QQQJ's investment thesis is quite simple. The fund focuses on mid-cap tech stocks, which tend to see rapid financial growth and returns. This is readily apparent in a couple of the fund's larger holdings, including Roku, Trade Desk, and Etsy.
Although QQQJ's holdings themselves are quite good, what really sets the fund apart is related to how indexes affect investor inflows, valuations, and share prices.
Simplifying things a bit, we can say that a significant portion of U.S. equity investments and funds consist of passive index funds. Figures and calculations vary, but Bloomberg reports a 44% allocation to passive funds for U.S. equity, which roughly coincides with other figures I've seen.
Passive funds are, well, passive, tracking an index with extremely few, generally zero, changes and deviations. Indexes themselves have explicit rules governing their holdings and investments, including inclusion criteria, exclusion criteria, and weights. Indexes almost always follow their explicit rules and criteria without making any significant changes.
As indexes and index funds follow strict rules, and as so much investment is tied to these funds, market prices and valuations are strongly dependent on indexes. As an example, being added to a major index means a significant increase in investor inflows, leading to increased share prices. Being removed from an index has the opposite effect. This is such a clear-cut pattern, that investors have taken to 'front-running' index inclusions and exclusions, to benefit from the almost-certain increase in share price.
There are many examples of this, but Tesla (TSLA) is probably the most well-known. Tesla's share price skyrocketed in early 2020, on the back of both improved fundamentals and bullish market sentiment. The company became so large that it merited S&P 500 inclusion. Investors decided to buy the stock before it was included in the index, leading to a skyrocketing share price. Tesla was up 740% during the year, with around half the gains occurring in the 2/3 months before its index inclusion.
Tesla has performed very well since too, but most of the company's returns occurred before it was included in the S&P 500. Early active traders and investors saw much greater gains than slower, passive investors.
Seems quite clear that it is better to invest in a company like Tesla, before it is included in major stock market indexes than after. Doing so should lead to strong returns, as was the case for Tesla. There are a couple other examples of this, Moderna (MRNA) is another well-known one. QQQJ attempts to do just that, but for the Nasdaq 100 index.
As a refresher, the Nasdaq-100 is a U.S. equity index, with a strong mega-cap and tech tilt. The index is overweight large tech stocks like Apple (AAPL), Microsoft (MSFT), and Google (GOOG) (GOOGL), and so is sometimes used to benchmark large-cap tech portfolios and funds. The Nasdaq-100 is tracked by QQQ, a $190B behemoth, and a popular fund for tech retail investors. Being included in the Nasdaq-100 leads to significant inflows and buying pressure, ultimately resulting in rising share prices. Before being included in QQQ, top 100 Nasdaq companies, stocks are included in QQQJ, top 101st to 200st Nasdaq companies. QQQJ is basically a stomping ground for QQQ and mega-cap tech stocks, and includes several high-growth stocks which might be included in the Nasdaq in the coming years. By investing in QQQJ, you are investing in the next generation of Nasdaq-100 stocks before these are included in the index and see skyrocketing share prices. Basically, investing in QQQJ is like investing in Tesla before the company's S&P 500 inclusion. Doing so should lead to strong, market-beating returns.
As QQQJ is quite new, we can't really meaningfully analyze its performance. As mentioned previously, it has underperformed the S&P 500 since inception, but barely so.
The backtest is more promising, with QQQJ's underlying index outperforming most comparable indexes and funds since 2009.
Finally, I took a look at the most recent additions to QQQ, and it seems that they all massively outperformed prior to their inclusion. Point being, investing in stocks before they are included in QQQ seems to be a successful strategy. QQQJ invests in these best-performing stocks, which should boost returns moving forward.
(Source: Seeking Alpha - Chart by author)
Conclusion - Buy
QQQJ is a mid-cap tech-heavy growth ETF. The fund invests in companies with the potential to join the Nasdaq-100 index, and benefits from the strong returns which are common prior to a stock's inclusion in a major index. As such, I think the fund is likely to outperform in the coming months and years, and is a buy.
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