Bank of America analysts are advising investors to favor Nasdaq-100 upside and its volatility over the S&P 500, citing several structural forces that could amplify the Nasdaq index's sensitivity to large, fast-growing tech and AI listings.
At the center of BofA's view is survivorship bias. The bank estimates that since the emergence of ChatGPT in late 2022 - which the analysts treat as the start of the current AI era - survivorship bias has exerted roughly twice the influence on the Nasdaq-100 as it has on the S&P 500. In market-cap-weighted benchmarks, that dynamic benefits passive holders: winners gain larger index weights while underperformers are removed, concentrating gains in a smaller group of successful names.
Nasdaq has proposed changes to its index methodology that, according to BofA, could further accelerate the pace at which newly listed Nasdaq stocks join the Nasdaq-100. Those proposals could permit faster inclusion of Nasdaq-listed IPOs and make passive index trackers a material buying force for fast-entrants to the NDX, even if those companies begin with initial free floats below 10%.
The bank warns that, if the IPO pipeline for tech and AI companies delivers as expected, NDX membership could become even more concentrated in those sectors, with underperformers potentially exiting the index more quickly under the proposed rules.
BofA provides a numerical assessment of how volatile a large, potentially newly listed NDX entrant might be. Using peer comparables, valuation signals from perpetual futures, secondary market transactions and the behavior of public funds that hold material pre-IPO allocations, the analysts estimate a 100% to 120% volatility range for such a stock. BofA notes this is roughly three times average NDX stock volatility and may be conservative where initial free floats are low.
On the index level, the bank expects the addition of such high-volatility entrants to exert a modest effect at first - approximately a 0.1 volatility point increase in the NDX. However, that impact could grow materially over time, potentially reaching as much as 1.1 volatility points in the event of a large listing or a meaningful rise in free float.
Because the Nasdaq-100 is already more concentrated in technology and AI than the S&P 500, BofA argues the gap between the two indices is likely to widen under the proposed Nasdaq changes and a robust IPO calendar. The bank also highlights a historical pattern: when an asset class is driven by a strong thematic surge - in this case AI - concentration can outperform diversification until the thematic bubble peaks, and volatility tends to rise as prices climb during the bubble's inflation.
Based on these dynamics, BofA recommends specific trades to capture potential NDX relative outperformance and elevated volatility. The bank suggests long-dated NDX versus SPX relative performance and volatility structures, including a conditional outperformance position maturing in December 2027 that historically would pay roughly three times the average payout ratio, and which could deliver up to a 13 times payout in a bubble scenario. As an additional volatility-oriented idea, BofA proposes a December 2027 NDX-SPX variance switch, citing an expected risk-reward outcome greater than 5-to-1.
Key takeaways
- Survivorship bias has had about twice the impact on Nasdaq-100 as on the S&P 500 since late 2022, favoring large winners in market-cap-weighted benchmarks.
- Proposed Nasdaq index methodology changes could accelerate inclusion of Nasdaq-listed IPOs and make passive funds important buyers even for companies with initial free floats below 10%.
- BofA projects 100% to 120% volatility for a large newly listed NDX entrant and anticipates an initial 0.1 volatility point effect on NDX that could grow to 1.1 points with larger listings or rising free floats.
Sectors impacted - Technology, Artificial Intelligence, Passive Indexing, and Equity Markets.
Risks and uncertainties
- Volatility risk - The arrival of high-volatility NDX entrants could raise overall index volatility, affecting investors in technology and AI-heavy benchmarks.
- Concentration risk - Increased weight of large tech and AI names could amplify index concentration, reducing diversification benefits for index investors.
- Index methodology and IPO pipeline uncertainty - Outcomes depend on the adoption and details of Nasdaq's proposed methodology changes and the actual pace and size of the IPO pipeline.