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Goliath gets a dose of realism: Does the average investor understand how Nasdaq’s re-evaluation of Apple’s weighting could affect markets?

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Nasdaq had to reshuffle. It hadn’t touched weightings since 1998. Nasdaq decided it’s not in investors’ interests to have one holding representing over 20 per cent of the index. And it’s right, such an over-weighting doesn’t represent an investors’  best interests.

It’s been said before, and it’ll be said again, one company’s over-weighting in an index counters the principles of proper asset diversification. Think Nortel and what happened when it was hugely dominant in the Canadian stock market. When Nortel got crushed in the tech bubble so did Canadian investors — many  watched their portfolios bomb.

Investors have definitely benefited from Apple’s meteoric rise over the last few years, however, at some point, rational thinking has to prevail. Do you really want the extra risk associated with an enormous weighting?

How many investors buying the Nasdaq know how overweight Apple is? In slashing Apple’s weighting about 8 per cent down from 20 per cent, Nasdaq’s doing the responsible thing.

Apple has been getting an enormously disproportionate share of the market due to its dominance of the Nasdaq. Apple’s been profitable but so have other companies.  In comparison, Microsoft, posting profitable quarter after profitable quarter, hasn’t been getting its due. And it pays a dividend!

Perception often rules over reality in the markets. But reality often comes back with a smack.

In the short-term, there will definitely be re-weightings of Nasdaq stocks in portfolios the world over. These re-weightings should benefit Microsoft, Cisco, Oracle and Intel. Apple stock should experience some interim pressure as managers adjust their portfolios over the next month.

What the future holds is as yet unwritten, yet Nasdaq’s re-weighting of the benchmark will be a wise long-term move for the index.

While the Nasdaq is nowhere near the valuations of the tech bubble, Apple has done almost nothing but go up since the financial crisis. However, during the volatility of the crisis, it got hammered.

Portfolio managers are measured against the indices that are their benchmarks. A benchmark should never be overweight one stock. It forces managers who want to compete with the index to buy more of the very stock they should be cautious about.

Here’s a graph and story of what happened to the Nasdaq after the tech bubble, when mania overcame rational, strategic thinking.

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