(Forbes) - It's no secret that passive investing using index-tracking funds has taken the world of investing by storm, taking a bite out of active managers' AUMs. Perhaps the most common index to track is the S&P 500, but one hedge fund manager believes the roughly $3 trillion invested in S&P funds is in the wrong place.
However, he's not advising these investors to switch to active management. Instead, he suggests that investors set on tracking an index should target the NASDAQ NDAQ -0.1% indices instead.
How the NASDAQ and the S&P 500 have changed
Robert Zuccaro of the Golden Eagle Growth Fund notes that the NASDAQ was introduced in February 1971 to tie together some 5,000 market makers that made markets in over-the-counter stocks. However, the makeup of the stock exchange has changed dramatically since then.
"When the NASDAQ was first introduced, the major stocks were AETNA, Connecticut General, Travelers and American Express AXP +2%," Zuccaro said in an interview. "There were virtually no tech stocks back then because tech had not come of age. Apple AAPL +0.7% came public in 1980 and Microsoft MSFT +2.4% in 1986. Today tech represents about 60% of overall NASDAQ weighting, compared to approximately 36% for the S&P 500 Index, according to my findings."
Given the NASDAQ's shift from insurance and financials to technology, things have changed dramatically over the years. The S&P 500 has changed significantly too.
Why he recommends tracking the tech-heavy NASDAQ instead of the S&P 500
The NASDAQ and the S&P 500 have changed so much over the years that, for some purposes, it might not even make sense to make a historical comparison of performance between now and decades ago. They are hardly the same now as they were years ago, so any comparison is not an apples-to-apples comparison. However, such a comparison is helpful when studying the effect the addition of technology has had on these indices.
For Zuccaro, what's important now is the focus on technology. While both the NASDAQ and the S&P 500 are heavier on tech than they were when tech companies first started dipping their proverbial toes in the public waters, the NASDAQ is far heavier tech-wise. Since Zuccaro's Golden Eagle Growth Fund tracks the 25 fastest-growing companies, his strong preference for tech comes as no surprise.
"Technology will continue to grow in importance, given 5G technology, which has potential to increase computer speed by 1000x — a giant leap over 4G, which increased speed by 50x," Zuccaro states. "Investors interested in indexing would be better off owning the QQQs rather than the Spiders (SPY)."
NASDAQ 100 versus NASDAQ Composite
Of course, there are two indices that enable you to capture the performance of the NASDAQ. The NASDAQ Composite includes all of the stocks listed on the exchange, while the NASDAQ 100 is a large-cap growth index that includes 100 of the top companies based on market capitalization. Investors can choose ETFs or mutual funds that track either one of these indices.
"Since the introduction of the NASDAQ Composite Index in 1971, this index has increased 161x, versus 41x for the S&P 500," Zuccaro notes. "The S&P is a total return index, which includes reinvestment of dividends, whereas the NASDAQ return is index-only. It is a mystery to me why no one has yet to create a total return index for the NASDAQ Composite."
A Google GOOG +3% search for a NASDAQ Composite Total Return Index does turn one up, but Google's index does not go all the way back to the inception of the NASDAQ Composite. The max view dates back to September 2009.
Zuccaro is one of the original quants, so it comes as no surprise that he has developed one of the longest histories of stock market returns. Golden Eagle Strategies has built the oldest databank on aggressive growth, growth and value indices.
Those indices start with the Wiesenberger Mutual Fund Style indices, which date back to 1958. They closed in 2005, so he picked up the relevant Frank Russell indexes afterwards to construct a long window on styles."
NASDAQ and S&P 500 returns
So is Zuccaro right that investors would be better off tracking the QQQs instead of the SPDRs? A review of the data from different angles provides the answers.
Since September 2009, the NASDAQ Composite Total Return Index has been up by more than 600%, while the S&P 500 Total Return Index has gained about 580%. Those returns show that the NASDAQ Composite is ahead, but not by as much as some might expect.
However, the performance difference becomes much more pronounced when you exclude dividends. Excluding dividends, the NASDAQ Composite has returned more than 7,000% since its inception in April 1982, compared to the S&P 500's return excluding dividends of more than 3,600% over the same timeframe.
Looking at some of the most popular passive funds that track these indices, the SPDR family of exchange-traded funds is managed by State Street Global Advisors and consists of different funds that track the S&P 500 in different ways. For example, SPY is the flagship benchmark that tracks the S&P 500 as a whole, while the SPDR S&P Dividend ETF tracks the S&P High Yield Dividend Aristocrats Index.
On the other hand, the QQQ family tracks NASDAQ stocks in different ways and is managed by Invesco IVZ +0.8%. The primary ETF in the family is listed under the QQQ ticker and tracks the 100 largest NASDAQ-listed companies.
SPY versus QQQ in performance
History shows us that the NASDAQ 100 has significantly outperformed the S&P 500 since the dotcom bubble in 2000, including during the downturns when that bubble burst and the Great Recession in 2008. As a result, the numbers show why Zuccaro advises investors to track the QQQ instead of the SPY.
If we look at the return data for the QQQ and the SPY over one-year, five-year and 10-year windows, we see just how dramatic the NASDAQ's outperformance is over the S&P. Over one year, SPY outperforms QQQ only one-third of the time.
Over five years, SPY underperforms QQQ more than 80% of the time, with an average difference of about 35%. Over 10 years, SPY outperformed QQQ just a tiny fraction of the time, and over some decades, QQQ outperformed SPY by more than 300%.
Of course, it's important to note that QQQ offers less diversification than SPY, although even SPY consists of a sizable weighting on tech. Additionally, QQQ includes only NASDAQ-listed companies, which means names like Salesforce, Oracle ORCL +1% and Block are excluded from it because they are on the New York Stock Exchange.
Why do the SPDRs' and QQQs' performances differ so widely
When comparing the holdings of SPY and QQQ, on the surface, it looks like it shouldn't matter whether you're tracking the S&P 500 or the NASDAQ because the top 10 holdings of these two ETFs are nearly identical. QQQ's top 10 holdings are Apple, Microsoft, Amazon, Tesla TSLA -0.7%, Alphabet Class C, NVIDIA NVDA +2%, Alphabet Class A, Meta Platforms Class A, Costco and Broadcom AVGO +0.2%.
On the other hand, SPY's top 10 holdings are Apple, Microsoft, Amazon, Alphabet Class A, Alphabet Class C, Tesla, NVIDIA, Berkshire Hathaway Class B, Meta Platforms and UnitedHealth Group UNH +0.6%. As you can see, the top three holdings are identical, and eight of the top 10 holdings are the same. However, where these two ETFs differ dramatically is in their weightings.
For example, Apple carries a weighting of 6.93% in SPY but 12.59% in QQQ. Microsoft's weight is 6.04% in SPY and 10.1% in QQQ, while Amazon has a weight of 3.61% in SPY and 7.13% in QQQ. If you compare the weightings across both ETFs, you'll see that QQQ has a much heavier tech weighting than the S&P 500.
As you can see, the difference in performance between SPY and QQQ is due to the weightings of their constituents.
Michelle Jones contributed to this report.
By Jacob Wolinsky
April 13, 2022
