Investors lose $5 billion on Tesla’s S&P entry

Tesla’s entry into the S&P 500 Index has cost investors benchmarked against blue-chip US stocks more than $45bn since December.

The world’s leading electric vehicle maker was finally admitted to the S&P in 2020, and its stock which had skyrocketed 764 percent before admission, fell in the following six months and the stock it had replaced—Apartment Investment and Management–increased by 48 percent. This rebalance cost investors 41 basis points, according to Rob Arnott, chair of RA, which in actual terms translated to a huge sum as the S&P 500 is tracked by about $4.6trillion of capital, and with $6.6 trillion benchmarked against it.

“AIV outperformed Tesla by a stupendous margin,” Arnott said in a blog post. “A pensioner with a $100,000 allocation to the S&P 500 is about $410 poorer as the result of the December index rebalance. Unfortunately, this cost is totally unnoticed by investors because it is baked into the index’s performance.”

Tesla recalls Model 3

Model 3 (Image: Tesla Press Kit)

Tesla’s market capitalisation at its entry was equal to the total market cap of the nine largest automakers by sales volume, which between them accounted for 94 per cent of global sales in 2020, according to Research Affiliates, a Californian investment house.

So, what is rebalancing? S&P Global and Nasdaq adjust the constituents of their indices regularly. New stocks that meet the market cap and profitability requirements are added to the indices, and companies that drop below the threshold for inclusion are removed. The S&P 500 index is rebalanced on a quarterly basis, while the Nasdaq 100 is rebalanced annually.

Market cap-weighted indices result in “buy high sell low” when they rebalance. Given the volatility associated with the rebalancing, traders should always pay attention to the stocks going in and out of major indices.

The last two decades have seen 23 new stocks enter the S&P 500 index due to mergers, acquisitions or bankruptcy or as a result of growth, says Research Affiliates. About 65 percent of these new entrants see their share prices rally between the announcement of their admission and the day they are actually listed, found Research Affiliates. Additionally, it found that 60 percent of the deletions from the index fall between announcement and exit dates. These deletions underperformed additions by 6.2 percentage points over this period, and went down another 1 percent after the change. In contrast, the next 12 months prices move in the opposite direction— the additions underperform the index slightly, but deletions go up on an average by almost 20 points. (case in point Tesla and AIV).

Consequently, investors routinely lose 20-40bp a year from “stocks [being] added at too high a price and sold at too low”, during the rebalancing process. “Traditional indices embody built-in performance-dragging inefficiencies,” Arnott wrote. “The index rebalance is a great opportunity . . . to do the opposite of what the index does: buy the deletion and sell the addition.”

Vitali Kalesnik, director of research for Europe at Research Affiliate, said the rebalancing effect becomes more intense as hedge funds buy up stocks of companies that are to be listed knowing that ETFs on the index will be buying these stocks once they are listed. “Who benefits from this? hedge funds and other liquidity providers. Who pays? The investors, a lot of which are pensioners that hold collectively billions of dollars in the S&P,” Kalesnik said. “This applies to all indices and strategies whenever any trading pattern becomes predictable and can be front run.”

Aye Soe, global head of product management at S&P Dow Jones Indices, disagrees, She says that data suggested the rebalancing-related losses had reduced in the past decade. “Market cap-weighting is the only way to show proportional representation of assets in an aggregate way, it’s the only macro consistent way,” she added. “People criticise it, but if you look at active managers, most can’t beat it.”

Research Affiliate says there are ways to lessen the impact. Select additions based on their five-year average market cap rather than hot stocks that have sudden rises.

Kalesnik said any investor able to postpone the trading of the S&P 500’s additions and deletions by a year “can outperform the index”. Base your picks on the whole market of stocks rather than just the “very narrow” S&P 500.

Gareth Parker, a former director of index research and design at S&P and is now chairman and chief indexing officer of Moorgate Benchmarks, says that the selection methodology for the S&P 500 was “not ideal”. “It is essentially ‘active management’. They don’t follow objective, transparent rules. “The result is anomalies such as adding Tesla, and from memory Google and Microsoft, far later than would have happened if the rules followed the normal approach of adding by size, subject to basic eligibility criteria,” Parker said.

However, he does not agree with the market cap-weighted mantra of “buy high sell low” given that the S&P 500’s track record “is remarkably good when compared to active management, even before fees”. 

Anna Domanska
Anna Domanska is an Industry Leaders Magazine author possessing wide-range of knowledge for Business News. She is an avid reader and writer of Business and CEO Magazines and a rigorous follower of Business Leaders.

Recent Posts

Tesla Cybertruck V/s Rivian’s R1T

Tesla Cybertruck V/s Rivian’s R1T

The Tesla Cyberturck left many disappointed with its alien space ship-like design; though both trucks are still under production, what matters most is what comes under the hood.
15 hours ago
College sports is multibillion dollar industry in the US

College sports is multibillion dollar industry in the US

According to data analyzed by GOBankingRates, head football coaches, closely followed by basketball coaches, easily rack up seven-figure salaries in the US.
2 days ago
Top women influencers in finance and wealth management

Top women influencers in finance and wealth management

It is only in the last century or so that women have been publicly acknowledged for their roles as leaders in various fields. Here’s a list of women influencers by Industry Leade
3 days ago
Brian Goldner, who led Hasbro’s transformation into an entertainment giant, passes away at 58

Brian Goldner, who led Hasbro’s transformation into an entertainment giant, passes away at 58

Brian Goldner, the CEO and Chairman of toymaker Hasbro, has died at age 58, the company said Tuesday (Oct. 12).
4 days ago
JPMorgan Chase CEO Jamie Dimon slams Bitcoin as worthless

JPMorgan Chase CEO Jamie Dimon slams Bitcoin as worthless

JPMorgan Chase CEO Jamie Dimon took another potshot at Bitcoin on Monday by calling the cryptocurrency “worthless” likening trading BTC to smoking cigarettes.
5 days ago
Refiner Eneos to buy Japan Renewable Energy for $1.8 billion

Refiner Eneos to buy Japan Renewable Energy for $1.8 billion

Eneos Holdings, Inc., Japan’s biggest refiner, announced Monday it would buy Japan Renewable Energy (JRE) for $1.8 billion to expand its low-carbon businesses.
6 days ago