Fidelity's New Tech ETF Is a Winner

10/21/2009 1:00 pm EST

Focus: ETFS

Scott Burns

Director of ETF Analysis, Morningstar, Inc.

Scott Burns, director of Morningstar’s exchange-traded securities analysis, and analyst John Gabriel say Fidelity’s first ETF is a good way to get exposure to the Nasdaq.

Fidelity Nasdaq Composite Index (Nasdaq: ONEQ) offers investors large-cap growth exposure with a technology sector tilt and a sprinkling of mid- and small-cap stocks. This ETF contains all of the nearly 2,000 stocks listed on the Nasdaq [Composite Index]. The ubiquitous Cubes, or PowerShares QQQ (Nasdaq: QQQQ), on the other hand, is composed of only the largest 100 nonfinancial firms that list on the Nasdaq.

ONEQ’s benchmark also adheres to a traditional market-capitalization scheme, whereas quirky adjustments to the Nasdaq 100 Index make Apple (Nasdaq: AAPL)—which has a market capitalization of about $162 billion—its top holding at more than 14% of the index.

The Nasdaq Composite differs from the more popular Nasdaq 100 in two ways: The composite includes financial stocks and owns more small-cap securities. While this alters the industry and sector compositions, the two indexes have still shown 98% correlation over the past three years. This ETF uses a representative sampling approach to tracking the benchmark.

In any case, we think investors should consider ONEQ a tactical investment for the satellite portion of their portfolios. Its concentrated sector exposures limit the overall diversification benefits, in our view. Technology stocks soak up more than 53% of the Nasdaq Composite Index. Over the past three years, ONEQ has displayed 94% correlation with the Standard & Poor’s 500 index and essentially represents that broad index’s entire tech component.

While ONEQ offers some small-cap exposure, it’s generally the same basket of large- and mega-cap tech behemoths with proven business models, long track records, and sustainable competitive advantages that dictate the fund’s performance.

As such, we think this ETF would hold up relatively well in a technology downturn but also may not rally as much in the event of a broad-based technology up swing. (Health-care names, consisting primarily of biotech firms, make up around 15% of the fund’s holdings.)

[Also,] with looming fears of inflation and a deteriorating US dollar, this fund’s sizable exposure to foreign-currency translation could prove to be a major positive. Additionally, a sizable chunk of tech spending is driven by corporate demand, which could help somewhat insulate this fund from a prolonged consumer-led recession.

In our view, an overwhelming majority of companies included in this ETF have displayed resiliency and should continue to be well insulated from the rapid innovation, short product cycles, and fickle infrastructure investments that inherently cause volatility in the tech sector.

While not the cheapest large-growth fund around, this ETF is still very inexpensive, with an expense ratio of 0.30%.

Investors looking strictly for exposure to the technology sector could also consider Technology Select Sector SPDR (NYSEArca: XLK) and Vanguard Information Technology ETF (NYSEArca: VGT). However, for those interested in gaining exposure to large-cap growth (which inherently overweights the tech sector), iShares Russell 1000 Growth Index (NYSEArca: IWF) and SPDR Dow Jones Large Cap Growth (NYSEArca: ELG) offer attractive alternatives.

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