Bye the Index

In the late 1990s, Nasdaq set out to democratize investing. Retail investors were already flocking to its exchange but many didn’t know what to buy. “We wanted to put investment and trading products in the hands of investors that were Nasdaq-branded,” recalls John Jacobs, then head of strategic planning. “You didn’t have to pick a Nasdaq stock – you could pick a basket of Nasdaq stocks.” The Nasdaq-100 index tracking stock launched in March 1999. It was an immediate hit. Listed under the ticker QQQ on Nasdaq’s sister venue, the American Stock Exchange, it accumulated $12 billion in assets in its first year. By the time it transferred to Nasdaq five years later, trading volumes had increased from 6.9 million shares per day to 100.3 million – and a million investors held it.1 As it grew, Nasdaq risked turning into an asset manager. An algorithm ran its investment process, but marketing required specialist resource. “So we looked around for a good partner,” says Jacobs, “and PowerShares was merging into Invesco, and when we talked to the team at Invesco they said we have 400 salespeople. Nasdaq had three. It was easy math to figure out that we would be able to broaden the distribution.” In partnership with Invesco, the fund continued to flourish. It charged investors 0.20% of net assets and ploughed much of that into marketing. As part of its deal with fundholders, any revenues left over after paying expenses such as licensing and trustee fees had to be used exclusively for marketing. With Nasdaq taking a licensing fee of around 0.08% of net assets and Bank of New York Mellon a trustee fee of around 0.04%, that left a lot to spend on ads. “I’ve been watching college basketball and have seen 10+ QQQ commercials. I don’t remember ever seeing this many specific investment advertisements, other than the crypto craze a few years ago,” posted one Reddit user. QQQ now sits on $456 billion of net assets, making it the fifth largest exchange-traded fund in the market. In the past five years, it has spent $749 million on marketing. Invesco recently succeeded in amending its agreement with fundholders to capture more of the revenue for itself. As part of the revised agreement, the fund’s charge falls slightly to 0.18%, but Invesco captures more of what remains – committing to a marketing budget of $60-100 million and retaining a revenue stream of around 0.04% of net assets.23 For Nasdaq, it has been a profitable endeavor. QQQ was its first exchange-traded fund – and remains its largest – but its index now sits inside multiple products listed all over the world. In the past 12 months, it earned $854 million in licensing fees, of which around a third are from QQQ. Licensing overtook cash equities trading as a source of earnings some time ago; now, for the first time, it has overtaken data and listings too. In the company’s core business of capital access and market services (excluding the newish financial technology businesses we discussed in Nasdaq’s Pivot) index licensing makes up a quarter of revenue – and the opportunity is still expanding. Nasdaq recently gave BlackRock and State Street permission to launch funds on the same pricing terms as QQQ, adding their distribution networks to Invesco’s.4 “A new chapter of growth and expansion for the Nasdaq-100,” said CEO Adena Friedman on her recent earnings call. The ascendancy of indexing is part of a broader trend as passive gains an increasing stranglehold over markets. Passive now accounts for 39% of total assets among the world’s largest 500 asset managers and over a third of US equity market trading. Add in active assets that use the Nasdaq-100 and other indices as a benchmark for performance and their influence grows. Now that influence is reshaping listings. Nasdaq talks often about flywheel effects – executives mentioned the idea 22 times at their investor day earlier this year. Listings were always meant to be the engine. But listings have stalled. Now Nasdaq is trying to run the flywheel in reverse – using the index to restart the listings engine. To see how, read on.