PowerShares QQQ ETF (QQQ) has established an impressive record. Over the trailing 10 years through March 2017, it outpaced the Russell 1000 Growth Index by 3.6 percentage points annualized, albeit with greater volatility. But a closer look reveals some critical shortcomings with the fund's underlying benchmark that limit its appeal. Most notably, the index has lopsided sector weightings, including a heavy stake in technology stocks, that it doesn’t explicitly target. These unintentional tilts are a source of risk. In addition, the index's focus on a single exchange (the Nasdaq) unnecessarily limits the stocks available to it. So, despite its strong record, modified market-cap-weighting approach, which promotes low turnover, and cost advantage against its actively managed peers, the fund earns a Morningstar Analyst Rating of Neutral.
The fund tracks the market-cap-weighted NASDAQ 100 Index, which includes the largest 100 nonfinancial stocks listed on the Nasdaq exchange. The Nasdaq is a tech-heavy exchange. Consequently, this sector soaks up over half of the fund’s assets and has a strong impact on performance. However, a pure tech sector fund would offer more efficient exposure to the sector. Concentration risk extends beyond this heavy technology weighting. Its top 10 holdings represent about half of the portfolio, exposing investors to some firm-specific risk.
Alex Bryan, CFA has a position in the following securities mentioned above: MTUM. Find out about Morningstar's editorial policies.