The Nasdaq-100: To Hedge or Not to Hedge Currency Exposure

By Richard Lin, CFA, Nasdaq Global Index Research

The Nasdaq-100 Index has remarkably outperformed other US equity benchmarks such as the S&P 500 in 2020, due its overweight towards new economy companies that have benefited from recent economic, technological, and social change. The rally of the Nasdaq-100 is supported by the longterm trend of technology innovation, the digital transformation acceleration during the pandemic period, and the Fed’s ultra-low interest rate expectations.

For global investors willing to invest in products tracking the Nasdaq-100, they have to face one extra hurdle – foreign exchange risk. Local currency returns in the Nasdaq-100 can significantly deviate from the US Dollar (USD) return of Nasdaq-100. Hence, Nasdaq offers the solution to use forward exchange contracts managing the currency risk in Nasdaq indexes.

Canadian Investors can track both unhedged and hedged Nasdaq-100 indexes: the Nasdaq-100 Canadian Dollar (CAD) Total Return Index (XNDXCAD) and the Nasdaq-100 Currency Hedged CAD Total Return Index (XNDXCADH). As the currency market is consistently evolving, investors should closely watch, research and use their best judgments when making the decision whether to hedge or not to hedge.

A Versatile Index for the Changing Times

The world was stunned by the outbreak of the Covid-19 pandemic early this year. Despite the heavy death tolls, huge job losses and a still very gloomy economic outlook, the stock market has accomplished a dramatic V-shaped recovery and continues reaching new highs. The Nasdaq-100 Index has returned 27.5% YTD, as of October 31, 2020, and significantly outperformed other major US equity benchmarks such as the S&P 500.

Performance of Nasdaq-100 and Other Major U.S. Stock Benchmarks (Year-to-Date)

There are several fundamental reasons analysts saw that may contribute to the rally of the Nasdaq-100 during the pandemic period this year.

Technology innovation is transforming nearly every business and redefining how we live, work, and play. Mega tech companies such as Apple, Amazon, Microsoft, Google and Facebook (the #1 to #5 ranked companies in Nasdaq-100) have not only been changing our everyday lives, but they’ve been driving the growth of the entire technology sector. New disrupters, such as Tesla (#6), Netflix (#10) or NVidia (#7) may also emerge over time, so that the names of those in the forefront of the sector may change eventually. Nevertheless, one thing that is highly unlikely to change, at least in the near future, is the growing dependency on technology by businesses and consumers alike. The Nasdaq-100 succeeds in capturing the mega theme of technology growth and offers the ability for one to track 100 of the most innovative public companies.

When the pandemic started hitting the U.S. in full force in early March, many states were forced to order restrictions, even lockdowns. People’s lives and business activities were inevitably and heavily impacted. Digital technologies, led by cloud computing, remote communications, and E-commerce, became the keys to keep the economy running and avoid another devastating collapse like the Great Depression of the 1930s. For example, analysts saw Zoom (#38)’s daily meeting participants increased from 10 million back in last December to over 300 million in April.¹ Netflix added 15.7 million global subscribers in the first quarter and another 10 million in the second quarter.² Dan Springer, the CEO of DocuSign (#49), the cloud-based electronic signature and agreement management company, has seen the company add more customers during the first half of the year than the entire 2019.³ He is also confident that the ongoing trend won’t easily fade away even after the pandemic ends. Nasdaq-100 companies may very well be the primary beneficiaries of this accelerated trend of digital transformation.

Unlike the dot com bubble nearly two decades ago, Nasdaq-100’s superior performance in the latest cycle is sufficiently supported by the robust long-term earnings growth. Since the outbreak of the pandemic, the Fed’s exceptional quantitative easing policies have created an ultra-low interest rate environment. The Nasdaq-100’s pandemic rally from March was mainly due to the stock market’s repricing of the discount rate. Theoretically, a P/E of 25 with 2% discount rate is equivalent to a P/E of 50 with 1% discount rate, with all else equal. The Fed’s recent statement, expecting to keep the target rate at current level between zero and 0.25% through at least 2023,⁴ means that the current Nasdaq-100 level can still be well supported until human societies win over the battle against the virus.