Exchange Traded Funds: The NASDAQ QQQ
Prudent investors look for ways to buy, sell, and trade on the stock market while at the same time trying to reduce their level of risk. "Diversification" is thrown around as what investors should have their portfolios look like, and many investors use mutual funds to help diversify their money holdings. But what if there was a better way? What if investors had the opportunity to buy and sell one security, and this security represented an entire stock market index?

Well, that is precisely what exchange traded funds (ETF) can do for one's portfolio. We will focus on a quite popular ETF -- the NASDAQ-100 Index Tracking Stock, also known as the as the NASDAQ QQQ. The NASDAQ-100 Index is composed of one hundred of the largest and most actively traded non-financial companies listed on the NASDAQ stock market.

The NASDAQ-100 Index Tracking Stock represents units of beneficial interest in an investment trust which holds the securities of the NASDAQ-100 Index. Shares of this stock can be treated as common stock and are traded on the American Stock Exchange under the symbol QQQ. The stock was designed to produce results that generally correspond to the performance of the stocks on the NASDAQ-100 index. These shares, while sponsored by NASDAQ, are placed in a NASDAQ-100 Trust that is administered by the Bank of New York.

The NASDAQ-QQQ allows investors to reduce risk by buying and selling the NASDAQ Composite through a single common stock. The stock is valued by weighing each of the 100 stocks equally. This can improve the results of investing, as the QQQ may not move in the same direction as the NASDAQ-100. Major companies such as Microsoft, Dell, Intel and Cisco sometimes are the only negative movers on the Composite Index, but since these companies are weighed equally in the QQQ, the QQQ stock may actually perform better on these days.

Trading began on this index-fund in January of 1985 and it reflects NASDAQ's largest companies across major industry groups, such as computer-related equipment and software, telecommunications, biotechnology, etc. Since these sectors can be dominated by a few companies, the index is evaluated and/or modified each quarter according to capitalization-weight distribution.

How are securities selected?
To be included in the NASDAQ-100 Index, a security first must trade on the National Market Tier of the NASDAQ Stock Market and must meet several trading volume and issuer criteria. The securities represented in the index are ranked by market value and are evaluated annually to determine inclusion. Additions or deletions are announced publicly in the early part of December. Any companies that get added to the index at this time officially become part of the NASDAQ-100 index at the close of trading on the third Friday of December.

What are the benefits of the NASDAQ-100 Index Tracking Stock?
The NASDAQ QQQ can be bought and sold at any time during the trading day. Also, by purchasing the QQQ one instantly acquires a broad-market portfolio by buying just one stock. There are no high management and sponsor fees, and one also gets the ability to sell short if the Index begins showing a downtick during the trading day.

How does the value of the stock correspond to the NASDAQ-100 Index?
The tracking stock was initially designed to trade at roughly 1/40th of the level of the NASDAQ-100 Index. For example, say that the NASDAQ-100 Index is at a level of 5,000. At this level, one should roughly expect the QQQ to be trading at $120 per share.

These values are, however, subject to fluctuation. Economic factors and vagaries associated with the stock market can be expected to cause movement in the NASDAQ-100 Index, in turn changing the value of the QQQ. The initial 1/40th pricing level cannot be expected to maintain itself in the face of these factors, not to mention factors such as supply and demand, transaction costs, and any expenses incurred by the Trust that administers the QQQ stock.

How has the QQQ performed?

As one can see from the chart above, the QQQ has traded in a tight range for the past year and is near its one-year low.

When one compares the QQQ price movement for the full month of March versus the movement on the NASDAQ, one sees that there is not a direct correlation with the index. The stock price for the QQQ generally trades in the same manner as the index, but there are some days where the movement has been in opposite directions. This suggests that while there is a relationship between the two, changes in one major stock like Microsoft or Intel may affect the entire NASDAQ Composite Index, while the QQQ may move in the opposite direction because all 100 of the stocks comprising the NASDAQ-100 are equally weighted and no one stock can affect the overall movement of the QQQ.

How does this affect the average investor?
The average investor is constantly bombarded with the advice, "Don't put all of your eggs in one basket!" The average investor can often be confused and disgruntled by the misshapen moves of the equity market. Exchange traded funds can be a nice way for market players to invest their money and experience the general moves of major stock indices. Using the NASDAQ QQQ as an example, investors would have been able to experience much of the positive momentum of the late 1990's in the technology sector by simply investing in one stock.

Damir Fonovich, Market Analyst, Econoday