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Fasten Your Seat Belt

By Smart Money
Published | Updated

Can you help me find a Nasdaq index fund?

QUESTION: I am looking for a Nasdaq index fund. Do they exist? Can you name a few?


ANSWER: You're probably not the only investor eyeing the Nasdaq, given that the tech-heavy index is almost 61% off its all-time high, which it reached on March 10, 2000. Before you run out and buy a Nasdaq-based index fund in hopes of a rebound, however, there are a few things you should consider.

First, the existing funds in this arena track the Nasdaq 100 Index, which includes only the 100 largest and most actively traded companies out of the 4,700 stocks that make up the Nasdaq Composite Index. And within the Nasdaq 100 Index, tech-industry giants occupy a hefty share: Microsoft (MSFT) accounts for 9.06%; Intel (INTC), 5.92%; and Qualcomm (QCOM), 4.67%, according to March 26 data.

As many investors know, these companies also have significant weighting within the S&P 500 index. So an overlap between a Nasdaq 100 index fund and an S&P 500 index fund — or another blue-chip portfolio — should be a concern, as the graphic above suggests. But it's even more likely that a Nasdaq 100 index fund will duplicate the holdings in a mainstream technology fund, says Alan Papier, an analyst at fund-tracking firm Morningstar. So chances are you'll want to hold one tech-oriented fund or the other, not both.

Without question, the Nasdaq 100's performance has been impressive (until recently): Its five-year annualized return as of Feb. 28 is 25.10%, compared with 15.91% for the S&P 500, according to fund-tracker Wiesenberger. But the Nasdaq 100 is also considerably more volatile: Its five-year standard deviation is 38.47 compared with the S&P 500's 17.16. "It's twice as volatile as the broad market. Therefore the returns will fluctuate dramatically," says Ramy Shaalan, mutual-fund analyst at Wiesenberger. The truth of that statement became all too apparent in the last couple of years: The Nasdaq 100 rose 101.95% in 1999 and fell 36.48% in 2000.

Volatility may be one reason the Nasdaq 100 Index isn't a foundation for more index funds. Its run-up in the late '90s did sow the seeds of several portfolios, but they're a small and inexperienced group — some 15 funds, about half of which were launched in 1999 or 2000. In comparison, the Standard & Poor's 500 index is tracked by 66 offerings, including the stalwart Vanguard 500 Index fund (VFINX), born in 1976.

The longest-standing Nasdaq 100 fund is the Rydex OTC fund (RYOCX), launched in February 1994. It boasts a 23.04% five-year annualized return, as well as a 98.8% tax-efficiency rating for that period, according to Morningstar. But at 1.15%, the expense ratio of this no-load index fund is relatively high. And the entry fee is too steep for most retail investors: Rydex Funds requires a minimum investment of $25,000, though it need not all be allocated to this portfolio. Some brokerage firms, however, will let you get into Rydex OTC for less.

Newer options include the California Investment Nasdaq 100 Index fund (sorry, no snapshot available), which launched in January 2000 and bears a reasonable expense ratio of 0.65%. There's also the OTC ProFund (sorry, no snapshot available) launched only last September by ProFunds, with annual fees of 1.60% but no load. Another year-2000 entry is the PaineWebber Enhanced Nasdaq 100 fund (sorry, no snapshot available), which aims to beat the index over the long term. It is available only in several load-bearing share classes, including one with a front-end load of 4.50% and a 1.28% expense ratio.

But a traditional mutual fund may not be the most attractive Nasdaq 100 tracking option, according to both Papier and Shaalan. Instead, they recommend looking at an exchange-traded fund, or ETF. The Nasdaq 100 Index Tracking Stock (QQQ), often referred to as Qubes or Cubes, is the most actively traded ETF on the American Stock Exchange, with a recent daily volume of almost 14.5 million shares, compared to 4.3 million for the Standard & Poor's Depositary Receipts (SPY). The ETF's expense ratio is only 0.18%, and it has the tax-efficiency advantages common to ETFs. But like all ETFs, it must be purchased through a brokerage, and that means trading fees.

The Nasdaq 100's volatility also invites the interest of short-term investors, who can best indulge their trading passions through the Rydex, Potomac and ProFunds fund families, since they don't charge exchange or redemption fees. For those who want to short the index, there's the Rydex Arktos fund (RYAIX) and the Potomac OTC Short fund (POTSX). There's also the Rydex Dynamic Venture 100 fund (RYVNX) and the ProFunds UltraShort OTC fund (USPIX), designed to deliver 200% of the inverse performance of the Nasdaq 100. Though these bear-market funds flourished last year, they should be used with care. The same goes for leveraged funds, such as the Potomac OTC Plus fund (POTCX), built to return 125% of the performance of the Nasdaq 100, and ProFunds UltraOTC fund (UOPIX) and Rydex Dynamic Velocity 100 fund (RYVYX), which aim to double the index's return.