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As of the end of last year, there were more than 3,800 exchange traded products, including exchange traded funds, listed in the U.S. so advisors can be excused if they’re not conversant in all those funds.
It’s not a reasonable expectation and the pace at which ETFs are born and die – the former usually outpaces the latter – makes it difficult if not impossible to be an experts on every single ETF on the market today. However, advisors are expected to be fluent in asset allocation and steering clients away from duplicative exposures.
That brings up an important, oft-debated question about whether or not investors should own both Nasdaq 100 Index and S&P 500 ETFs at the same time. This debate is often viewed through the lens of the Invesco QQQ (NASDAQ: QQQ) and the SPDR S&P 500 Trust (NYSE: SPY), but for the purposes of this article, we’ll use the Invesco NASDAQ 100 ETF (NASDAQ: QQQM) and the Vanguard S&P 500 ETF (NYSE: VOO) because those are the least expensive ETFs tied to those indexes.
Despite Differences, Big Overlap
To gain admittance to the S&P 500, companies must meet earnings, liquidity and volume thresholds, but the index is essentially a measure of the 500 largest stocks with primary listings in the U.S. On the other hand, the Nadaq 100 or NDX is collection of the 100 largest Nasdaq-listed firms that are not financial services companies.
Yet even with QQQM excluding financial services – a sector that accounts for 14.22% of VOO – there’s significant overlap between these two ETFs. Roughly 84% of QQQM holdings are also VOO components and the overlap by weight between the two ETFS is 48%, according to the ETF Research Center. Blame the ascent of growth stocks to which QQQM is heavily allocated.
When taking that overlap into account, it’s not surprising that QQQM is highly correlated to VOO. Over the past three years, the former’s correlation to the latter was 0.92, according to Morningstar’s Amy Arnott. So when VOO declines, QQQM is likely to follow suit and it could be the worse offender if tech stocks are leading the way down. History proves as much.
“During the tech, media, and telecom correction that started in March 2000, for example, it suffered cumulative losses of nearly 77%, compared with about 33% for the overall equity market,” notes Arnott.
She’s referencing QQQ because QQQM debuted in October 2020, but had it been around in 2000, its performance would have been comparably bad to QQQ’s save for the five basis-point advantage QQQM has in the expense ratio department.
Settling the Debate
Since QQQM’s inception, its performance advantage over VOO is negligible and it was accrued with significantly higher volatility. However, as mega-cap growth stocks led the market over the past several years, the gap grew wider.
Helped in part by a weight to tech stocks that often hovered around 50% or more, QQQM gained 45.2% for three years ending, Feb. 7, beating VOO by 770 basis points. Exclusion also helped the Invesco ETF as its weight to the lagging healthcare sector is about half that of VOO’s.
So when it comes to holding both ETFs, that’s probably something younger investors with the luxury of time can get away with. Advised clients ought to discuss the strategy with advisors, assuming it’s of interest, because it has some merit. It also has ample duplication and neither point should be ignored.
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