What is the QQQ ETF?

The QQQ ETF is also known as the PowerShares QQQ. This is one of the most widely held and traded exchange-traded funds (ETF). One reason for its popularity is that it tracks the Nasdaq 100 Index, which is populated by 100 of the largest U.S. and international companies (based on market capitalization) that are traded on the Nasdaq stock exchange. A defining feature of the Nasdaq is that it is the home of many companies in emerging markets, including technology companies. In fact, the Nasdaq is home to the widely popular FAANG stocks (Facebook, Alphabet, Apple, Netflix, Google) and all but Netflix are in the top 10 of their holdings as of this writing.

However, the QQQ ETF is also considered to be an unusual, albeit exciting, fund based on its composition and the way the fund assigns weight to its holdings. According to the rules established when the fund was created, the fund excludes financial companies. In fact, the QQQ ETF is concentrated in seven sectors that are weighted as follows*:

• Information technology – 59.49%
• Consumer discretionary – 21.69%
• Health care – 9.04%
• Consumer staples – 5.95%
• Industrials – 2.64%
• Telecommunication services – 0.85%
• Utilities – 0.34%

*As of 1/24/19

The fund also uses a weighting system that is concentrated on its largest holdings which means it has significant exposure to the technology sector, including some of the largest and most innovative companies. For example, Apple recently had a market cap that was briefly over $1 trillion and is still around $900 billion. Google, Microsoft, and Amazon continually show strong operational cash flow. Amazon, in particular, has shown quarter after quarter of strong top-line revenue numbers.

• com, Inc. – 10.05%
• Microsoft Corporation – 10.02%
• Apple, Inc. – 9.02%
• Alphabet Inc. Class C – 4.69%
• Facebook Inc. Class A – 4.41%
• Alphabet Inc. Class A – 4.12%
• Intel Corporation – 3.02%
• Cisco Systems, Inc. – 2.72%
• Comcast Corporation Class A – 2.21%
• PepsiCo, Inc. 2.11%

However, despite the rules that define the fund's holdings and how they are weighted, the QQQ ETF is not considered a "tech fund". It provides investors with exposure to tech, large-cap, and growth stock companies. With that said, the fund's top 10 holdings currently make up 52.37% of the fund's holdings as of this writing.  

In addition to its focus on some of the most innovative, and rapidly growing, companies, the QQQ ETF also has a very low expense ratio (currently around 0.2%).

As you can imagine, the QQQ ETF isn’t the only player that seeks to profit its investors by investing in the technology sector. And while the PowerShares QQQ, at 18 years old, is considered to be one of the giants in the sector, it can seem downright vanilla when compared to the flavor portfolio of some other ETFs that have arisen in the sector. One of these is the ProShares UltraPro QQQ or the TQQQ ETF. TQQQ was created as a way to give investors a more exotic way to trade the Nasdaq 100 index.

The objective of the TQQQ ETF is to deliver three times the daily return of the Nasdaq 100 index. This means that if the index climbs 1% on a trading day, the TQQQ should, in theory, rise by 3%. What allows the TQQQ to target gains of this size is that it is a leveraged ETF, which means that it uses financial derivatives and debt to significantly increase the returns of the underlying index that it trades.

For an investor, the choice of choosing one fund over the other really comes down to their investment philosophy. The TQQQ ETF seeks to capitalize on the momentum of a stock and relies on a high degree of volatility in price movement. Therefore it is geared towards active traders who have a high-risk tolerance. By contrast, the PowerShares QQQ is more suited for long-term "buy-and-hold" investors. With one fund, the investor has exposure to a highly liquid, cost-efficient fund that features a mix of large-cap innovative companies weighted to the tech sector.

And for investors who are concerned about fees and expenses, the TQQQ has an expense ratio much closer to 1% which is typical for leveraged ETFs, compared to the 0.2% expense ratio of the QQQ.

A high percentage of exchange-traded funds have a mutual fund counterpart that trades the same sectors or securities. The QQQ ETF is no different. The Invesco QQQ Trust Series 1, for example, is a mutual fund that trades the Nasdaq 100.

ETFs and mutual funds share certain characteristics in terms of allowing investors to hedge against risk by spreading out their investment among a variety of companies. In the case of the QQQ ETF, many of these companies are in the technology sector which many investors would like to be active in, but may be concerned about the risks involved. However, while a mutual fund and ETF may be related, there are distinctly different.

Although there are differences in the way the funds are set up, the difference we want to focus on for the purposes of this article is the trading process between the QQQ ETF trades and a mutual fund index. In the case of a mutual fund, the price of the fund (and therefore the price investors shares are bought and sold at) is not set until the end of a trading day when the fund’s net asset value (NAV) is determined. By contrast, and ETF trades shares are created and subsequently redeemed by large institutional investors. Shares in the QQQ ETF, as with other ETFs trade throughout the day just like an equity stock. An ETF can also engage in short selling. In fact, the QQQ ETF has a companion ETF the ProShares Short QQQ that exists for just that purpose.

ETFs also have lower fees and expenses than mutual funds, particularly mutual funds that are actively managed. The QQQ ETF has an expense ratio of just 0.2%, which is another reason why it is popular among competing products.

An ETF and an ETN are related much in the same way that a convertible note is related to convertible preferred shares. The ETN is called a structured product and acts more like a bond because they are issued as unsecured, senior debt notes. ETFs, by contrast, represent an actual stake in their underlying security (stocks, bonds, gold, etc.).

An ETN is similar to a prepaid contract. For an investor, this means that when they buy or sell the difference will be treated as capital gains. ETFs on the other hand base their return on the interest from Treasury bills, short-term capital gains (calculated on the rolling of futures contracts) and long-term capital gains.

There is also a difference as it applies to the way ETNs and ETFs are taxed. In general, ETNs should be more favorable because short-term capital gains are treated less favorably than long-term capital gains. However, with an ETN, income taxes will have to be paid on any interest or coupon payments made by the ETN. This can be compounded for international investors because capital gains are treated differently in their home countries.

Another distinction between an ETN and ETF has to do with credit risk. If the issuer of an ETN would go bankrupt, there is no guarantee that an investor would receive their promised return. By contrast, an ETF possesses a virtually non-existent credit risk. However, owners of an ETF face the risk that their return could fall below the underlying index.

All investing involves a certain degree of risk and the QQQ ETF is no different. One measure to measure a fund’s safety level is to assess its quality. MSCI ESG Research LLC assigns funds a quality score and a peer rank that can help investors see where the fund stacks up to its peers and compared to other funds that trade in comparable sectors. The QQQ ETF had a quality score of 5.72 out of 10. The ETF ranked in the 88^thpercentile within its peer group and in the 57^thpercentile for all ETFs.

In addition, the QQQ ETF has been in the top 1% of the Morningstar's Large Growth category for the past 5 and 10 years*. Morningstar's ratings are based on a risk-adjusted return measure. This means that when calculating monthly performance, more emphasis is placed on downward variations and funds that produce consistent performance are rewarded. The overall rating is calculated using a weighted average of three-, five- and 10-year rating metrics, as applicable. The rating excludes sales charges but includes fees and expenses.