The Electoral Map of the Market: House of Representatives vs Senate
The Nasdaq-100 Index is among the most widely followed growth indices in the world. When you look underneath the hood of the index you will find that not all stocks are created equal. This is because the stocks with the highest market capitalization receive more weighting than those with a smaller capitalization. Currently, Apple Computer AAPL has the highest market cap, and thus receives the highest weighting at about 10.5%. On the other hand, Bed, Bath & Beyond BBBY carries a weight of just 0.13% as one of the smallest companies in the Index. This weighting methodology creates a portfolio where only a small portion of the stocks in the index have a meaningful impact on the index as a whole. Hence, the Top 25 stocks account for more than 70% of the movement of the Index. The other 75+ holdings fight over the remaining 30% of this Index.
To help explain this concept to your client, consider an example of the Congress of the United States, specifically the House of Representatives. The House of Representatives consists of 435 members from across the United States; however, each state does not have an equal number of representatives. Rather, each state receives seats in the House based on the population (like market capitalization) of that state. So, the more people that live in a state, the more seats in the House they will receive relative to the other states. For instance, based on estimated July 2015 numbers from census.gov, the United States had a population of 321 million people. The most heavily populated state in the country is California, which had a population of about 39 million or 12% of the country’s population. Therefore, the state of California receives 53 out of the 435 seats (12%) in the House based simply on the size of the state in terms of population. This is very similar to the way that Apple Computer receives the largest weighting in the Nasdaq-100 based upon having the largest market cap. The allocation of seats in the House gives the state of California, essentially, a 12% weighting. Next would be the state of Texas, which has 36 seats in the House for 8% of the vote. New York and Florida both have 27 seats for a 6% voting share.
On the other hand, states that have smaller populations do not receive as many seats. Therefore, Alaska, Vermont, Wyoming and the Dakotas have only one seat in the House each, which amounts to just 0.23% of the vote! Clearly, the House of Representatives is not an “equal-weighted” body of Congress as some states receive a much larger weighting. On the other hand, the other body of Congress, the U.S. Senate, is an equal-weighted entity in which each state receives the same number of votes regardless of population. The Senate consists of 100 seats, two from each of the 50 states. Each of the 50 states receives a 2% weighting in the Senate. So, while California and Wyoming both have the same weighting in the Senate, California has more than fifty times Wyoming’s weight within the House.
We bring this example to your attention because we have found that it serves as a great analogy when explaining the differences between a traditional market capitalization weighted product versus an equal weighted product. In the case of the Nasdaq-100, an ETF exists to represent both the “House” (cap weighted) and the “Senate” (equal weighted) versions of this index. In fact, there are currently about 8 products that target many (if not all) of the names in the Nasdaq-100 in their own way (outside of traditional cap weighting). Below we highlight some of these products and how they are put together.