SpaceX, Other Mega IPOs Denied Fast Index Entry by S&P
bloomberg.com569 points by tristanj 11 hours ago
569 points by tristanj 11 hours ago
Good. Indexes are supposed to be slow-moving, precisely due to their entry requirement of sustained profitability that skews towards mature companies.
All that an inclusion of these new companies would accomplish is a bailout of their stockholders by pension funds and ETFs where millions of regular people shoulder all the downside risk.
SpaceX and OAI stock will be available through Robinhood, Questrade and all the other retail investor markets. Individuals can make an informed choice to trade it there, rather than have it automatically added to their index fund without having any say.
>All that an inclusion of these new companies would accomplish is a bailout of their stockholders by pension funds and ETFs where millions of regular people shoulder all the downside risk.
Carvana is the poster child for this. It's astonishing that a company with a history of shady practices, and that has yet to offer a convincing explanation for why it is not a scam, is part of the S&P 500.
Ah, so you'd like the passive broad market index which contains the 500 biggest good companies?
Do tell us if you find one I guess.
You can just pick stocks - if you pick a fairly low number of large stocks in broad categories with correct weight, you will track the index.
And the relative values of those stocks will shift requiring rebalancing. You might be able to do that with new dollars for a while but hopefully, eventually, the swings are much more than new dollars and then what? Pay capital gains tax on sales to rebalance? Convince yourself the new random allocation is fine?
I thought the point of index funds weighting by market cap is that they don't require rebalancing, because the weight of stocks in the index exactly tracks price movements. You just keep holding the exact same number of shares, and more valuable stocks automatically take up more of your portfolio.
Yes, but parent poster was not talking about an index fund. Read grandparent post again.
If you pick stocks with the correct weight to track the index, you're effectively running an index fund. And so you don't have to rebalance to keep tracking the index.
If you never rebalance, you're never adding new stocks to the index, nor removing stocks that do not belong to it anymore.
Indexes rebalance frequently. The "correct weight" today, won't be the correct weight in a year.
What are you talking about? Those index fund are constantly rebalancing. This is why you buy an index fund, so you don’t have to constantly rebalance your portfolio.
what's the argument for it being a scam?
shady debt offloading onto its sibling financing entity, which is run by Carvana CEO's father, a man convicted of fraud
> a man convicted of fraud
Most practitioners in the field see that as a very strong signal of future fraud.
why go that far? herbalife moto is probably "we're a pyramid scheme scam" and they are 45% vs sp500 25% for last 12mo.
you'd better of investing scam500 than sp500 nowadays.
Herbalife has decades of profits from selling wannabe Herbalife distributors a dream of financial independence they'll never achieve though, which might be unethical but is a bit less likely to lose your pension fund money than a company accused of getting 73% of its earnings from a deal with a convicted fraudster...
Whenever someone says nowadays, they're highlighting recency bias. The goals of holding a broad market ETF are diversification leading to sleeping well over the long term (at least to me).
Crime pays. But when you go that far, why stop at investing in scams? Surely you can make money faster by robbing old ladies at knifepoint?
How well do SCAM500 stocks do over a time period that includes two recessions, compared to SP500 ones?
I've no doubt that the short-term gains during a bull market on all sorts of garbage are significant.
Also worth noting that other index providers are less principled.
> Nasdaq changed its rules recently so SpaceX can join the Nasdaq 100 Index, a cohort of the largest non-financial companies listed on its exchange, in just 15 trading days, down from a three-month minimum. FTSE Russell adopted a similar approach, shortening the waiting time to five trading days
It’s important to note that index funds will eventually get in, so it’s not like 401k will never be holding these stocks. It would be silly to assume that the stock is going to tank that much on day 1, on the asumption that there are not enough investors to buy the big three IPOs that are coming out this year. There is plenty of money in the market, and everyone knows index funds will buy these stocks when the companies get in, so everyone will be able to dump them if needed in a year or so.
Btw I don’t really know how index funds work, but if they need to track the index as closely as possible, they will all have to buy those stocks on a certain day, no? There will be a crazy price hike when they do so. Or maybe they have terms that let them smoothen their trading around entry and exit?
To a first approximation, yes, the index funds all need to buy the stock on the same day.
An unexpected surge of buying like this should lead to a big price hike. But everyone knows it's happening, so you'd expect every hedge fund and proprietary firm in the world to buy the day before the index funds buy, and sell into the price hike. So in fact the price hike will be a day earlier than expected. But wait, anyone smart enough to see that should buy the previous day...
In this way the "smoothing" of the trading at entry and exit gets passed on to intermediaries: other market participants who are expert at this.
This all costs the index funds, because every dollar of profit for the other firms is a dollar out of the pocket of the end investor. And huge index events like this are a particular bonanza for these traders. But it probably costs less than you think. Ultimately it's a highly competitive market: the slippage from this approaches the extent to which the prop traders have a higher cost of capital, plus a small risk premium. And remember that they don't have to find "extra" money to fund this trade. When they buy SpaceX they will sell 499 other stocks, doing the same trade there in reverse. Here's a study that approximates the effect at 0.86%[0]. By comparison, the banks underwriting the IPO typically take around 6% [1]. Though this will be smaller for a huge IPO like SpaceX, while the index arb trade will be bigger.
[0] https://www.eastspring.com/hk/insights/deep-dives/navigating...
[1] https://www.pwc.com/us/en/services/consulting/deals/library/...
0.8% of drag is a lot when you can do basically the same thing by not strictly following the index.
There are funds from Dimensional and Avantis that are basically just index funds but with a bit more leeway to avoid these obvious pitfalls, and from what I saw they do perform approximately 0.5% better per year.
0.8% is substantial indeed, but if i understand correctly, it’s 0.8% on that one stock, so much less on the index itself.
Those funds that perform better probably take a higher management fee that might cancel out the gain. May be worth it to have a smoother return though.
>This all costs the index funds, because every dollar of profit for the other firms is a dollar out of the pocket of the end investor.
This is so wrong I'm not sure you understand common sense economics and by economics I don't mean anything you can find in a text book. If I invest nothing, the other investors or traders can still make a profit without costing me anything.
Opportunity costs are never real costs. If I have $10, and the traders do weird things with the prices and I don't spend the $10 on anything, I still have $10. The traders failed to cost me.
You're also ignoring the underlying issue which is that the valuation of SpaceX on the open market is different than the valuation it could get from forcing index funds to buy in early. If the stock is worthless then short sellers will make money, but short selling only works if the short sellers don't get squeezed. If the passive funds buy two weeks in, then early traders know that they can sell to a greater fool at inflated prices. Any short seller who is trying to discover the true price will stay back and short directly after the indexes have bought. That's the perfect moment for them. They want the post IPO hype and bull market, only for the stock to collapse within a year.
There's a real desire out there to tell a narrative where SpaceX is a massively fraudulent piece of financial engineering, a pump and dump scam where the stock will "collapse within a year" and retail investors will be left holding the bag.
There's definitely some financial engineering at the margins, but as I see it the facts are:
- Musk is still going to own 40% of the company. If he's selling 4% of it, his incentives are aligned with keeping the rest of it high
- the index funds ultimately are fast tracking the big IPOs because their customers, in aggregate, want that. And the market structure really has changed since the days when the index inclusion rules were first written and companies went public smaller.
- People have been banging the same drum about short sellers with Tesla since at least 2017 - AFAIK it's still one of the most shorted stocks - and it's up 20x since then.
- Institutional investors with more sophisticated strategies than "buy the index" or "pump and dump lol sell to the index funds" will be participating in the IPO and in fact will be the main drivers of price. Everything I've seen suggests that if this is a "retail heavy" IPO, that means 20 or 30% of the shares ending up with retail instead of a more typical 10. These other institutions could be wrong, but they're not mechanical price takers.
I've shown above how one of the effects people make the most noise about - the index balancing arbitrage - is likely an effect of order of magnitude 1%. It's on the noisemakers to show how any of the other effects you mention can be massively more impactful.
> There is plenty of money in the market
Their float will be very small so yes, the value of their shares that anyone could buy at even the most optimistic valuations would be tiny compared to most public megacaps.
> Btw I don’t really know how index funds work, but if they need to track the index as closely as possible, they will all have to buy those stocks on a certain day, no?
S&P wouldn't include them until they became profitable and even if they did they wouldn't even be in the top 20.
No, indexes are meant to track something. The Russel 2000 index has very different criteria for the S&P 500 index. The Dow Jones is yet another one.
The criteria for none of the above is “slow moving”, far from it. Those are all expected to be high growth vehicles for retirement. Safe stuff is bond blended.
Plenty of people at shit in the GFC being invested in “slow moving” S&P 500 companies like Lehman Brothers, WaMu, AIG, GM, etc.
“Was profitable for a while” != “safe” nor is it necessarily good to park money there. You need explosive growth companies that invest rather than profit (like Amazon) being in the S&P 500 are a critical part of its performance.
If retirements only tracked stable mature companies that would be utilities and other stuff that doesn’t actually get you to retirement.
>All that an inclusion of these new companies would accomplish is a bailout of their stockholders by pension funds and ETFs where millions of regular people shoulder all the downside risk.
The purpose of an index is to provide a benchmark of the market, not to build funds that follow the index.
> The purpose of an index is to provide a benchmark of the market
Usually a subset of the market based on specific criteria. Total market indexes and funds exist, maybe there is a reason S&P 500 despite its "strict" inclusion criteria is more popular than them?
On a fundamental level, the S&P 500 index is meant to be a benchmark of the market. Journalists, policymakers, investment managers, politicians, regular investors, everyone I know all use the S&P 500 as the benchmark of the US stock market.
If a significant percentage of the market is excluded from the index because they don't meet index inclusion criteria, then then index stops being a useful benchmark.
S&P500 is not a total market index. It tracks a specific kind of large firm, with certain filters.
Fast tracking means that the market likely wont have enough time to find the settled price (especially with the knowledge that passive funds are about to buy), and including a mispriced thing does not necessarily make the benchmark more accurate.
Those filters for S&P 500 inclusion criteria have changed many times. They are not sacred nor set in stone. The question is, do those filters, which were designed for GAAP profitable traditional companies & discriminate against fast growing cash-flow-reinvesting startups that prioritize growth over profit, unnecessarily exclude major players in the U.S. stock market? The S&P inclusion criteria reward companies that prioritize profit over growth.
SpaceX, Anthropic, and OpenAI are all giga-caps preparing to IPO, and none of them will be eligible for S&P inclusion because of the 12-month profitability requirement. At current valuations, all are part of the top 20 largest companies in the US. These companies may be excluded from the S&P500 for potentially years, until they reach 12 months of profitability.
And you are vastly overstating the effect of S&P500 fast track inclusion, the plan was to reduce it from 12 months to 6 months; which is more than enough time for the market to find a price.
> which is more than enough time for the market to find a price
The price markets find would still inevitably be influence by the knowledge that the demand would increase massively in a few months.
> inclusion criteria reward companies that prioritize profit over growth
Or stable and sustainable growth. Whatever else SpaceX, OpenAI, Anthropic valuations are price in extremely optimistic growth. But yeah, I do see a point that including adequately priced growth stocks could be a net benefit but of course accouting for the actual valuation would turn index funds into managed ones.
Thankfully its not an issue at all since there is Nasdaq 100.
> Under current rules, these fast-growing companies would be excluded from the S&P500 for potentially years, until they reach 12 months of profitability.
> And you are vastly overstating the effect of S&P500 fast tracking, the plan was to reduce it from 12 months to 6 months; which is more than enough time for the market to find a price.
They might never reach 6 months of profitability, let alone 12 months.
> If a significant percentage of the market is excluded from the index because they don't meet index inclusion criteria, then then index stops being a useful benchmark.
So what's the reason for fast entry specifically? If it's a significant portion of the market and will remain so, it doesn't need an accelerated entry. A benchmark should be conservative about new entrants so that it doesn't turn from a market benchmark to a trend/fad benchmark.
If time validates the valuations the entry will come in time, just like for previous entries.
Because the index needs accuracy. If a company is 1-2% of the total US market cap and not included in the index, then the index is wrong right now. The longer this company is not in the index, the longer this error compounds.
In the coming few months, multiple giga-cap companies (SpaceX, OpenAI, Anthropic) are all planning to IPO. These companies will likely never meet S&P profitability inclusion criteria for the next 5 years. These are not bad companies, but because the S&P inclusion criteria were written for old GAAP profitable companies, and not high-growth companies that invest their cashflow into company growth over profits. Excluding some of the most civilization changing companies from the benchmark means the benchmark is doing a terrible job.
"Because the index needs accuracy.", and I would argue that include price accuracy not just inclusion accuracy. The S&P is a benchmark that is designed to reflect a subset of the market, and giving only some companies early access to the benchmark changes the benchmark. So if you want a benchmark that's designed to include all the big stocks regardless of age, profitability, etc then go make a new benchmark. The only thing you need to do is convince others to use your benchmark.
"go make a new benchmark" completely ignores how this works in practice. Benchmarks are only useful because everyone uses the same one, you can't swap it out. The S&P 500 benchmark is used as a comparison for trillions of dollars of mutual funds, index funds, and institutional mandates. The further the S&P 500 strays from reflecting the actual market, the more useless it becomes.
Also the S&P criteria have been revised multiple times, it's not some sacred unchangeable document.
You want to turn S&P 500 to a total market index. Why? That was never its purpose.
No? Where did I say that?
The purpose of the S&P 500 is to be the "best single gauge of U.S. large-cap equities". That's direct from their website. I never dispute this.
I dispute the fact they claim to be the best benchmark of large-cap U.S. equities, yet have rules that (currently) exclude large-cap equities like SpaceX, OpenAI, or Anthropic.
Sure, but then it comes down to your opinion vs the S&P board's opinion. I suspect (given that there's only been a few days of this getting into the public eye) that more people support the S&P's position vs their critics. But the trade flows will show if people get out of SPX (or SPY/VOO) in the coming days.