Tesla’s entry into the S&P 500 costs investors $ 45 billion
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Tesla’s entry into the S&P 500 has cost investors the tracking or benchmarking against the blue-chip U.S. equity index more than $ 45 billion since December.
The electric vehicle pioneer was already the world’s seventh listed company when it was finally admitted to the S&P in late 2020 – more than a decade after entering other indexes such as the Russell 1000.
Its stock had risen 764% in the previous 12 months – partly in anticipation of forced purchases at the entry of the S&P 500 – and its market cap equaled the total market capitalization of the nine largest automakers by sales volume. , which together accounted for 94% of global sales in 2020, according to Research Affiliates, a California-based investment firm.
Tesla’s share price then fell in the six months after its admission, while the stock it replaced, Apartment Investment and Management (AIV), rose 48%.
This rebalancing cost investors 41 basis points of their portfolios, said Rob Arnott, chairman of RA, a tidy sum given that the S&P 500 is directly followed by around $ 4.6 billion in capital, with 6.6 billion. additional billions of dollars compared.
“AIV outperformed Tesla by an incredible margin,” Arnott said in a blog post. “A retiree with a $ 100,000 S&P 500 allocation is about $ 410 poorer as a result of the index rebalancing in December. Unfortunately, this cost is completely unnoticed by investors because it is built into the performance of the index.
While Tesla is an extreme case, analysis from Research Affiliates suggests that market cap-weighted indices have a clear tendency to consistently “buy high, sell low” as they rebalance.
Since 2000, an average of 23 stocks have entered (and exited) the S&P 500 each year, sometimes due to corporate actions such as mergers, acquisitions or bankruptcies among existing constituents, other times due to growth of companies outside the index.
RA found that 65% of new entrants see their stock price increase between the day their impending admission is announced and the day the change takes effect.
In contrast, 60% of discretionary deletions from the index fall between the announcement and exit dates. On average, deletions have underperformed additions by 6.2 percentage points over this period, plus an additional 1 point the day after the change was enacted as index trackers catch up.
Over the next 12 months, prices move in the opposite direction: additions on average underperform the index, but by only 1 percentage point, but deletions beat it on average by almost 20 points.
As a result, RA calculated that investors typically lose 20 to 40 bps per year because of “stocks”. [being] added at too high a price and sold at too low a price “during the rebalancing process.
“Traditional indices embody built-in inefficiencies that slow performance,” Arnott wrote. “The rebalancing of the index is a great opportunity. . . do the opposite of what the index does: buy the deletion and sell the addition.
Arnott, whose company is a proponent of factor-based smart beta investing, said this was not a criticism of S&P per se, but rather an inherent flaw in all. indices weighted by market capitalization.
Vitali Kalesnik, research director for Europe at RA, said the rebalancing effect is likely to be exacerbated by hedge funds buying stocks when their impending promotion is announced with full knowledge that index trackers such as ETFs will need to buy them when they enter the index.
“Who benefits from this?” hedge funds and other liquidity providers. Who pays? Investors, many of whom are retirees who collectively hold billions of dollars in the S&P, ”Kalesnik said. “This applies to all indices and strategies whenever a trading pattern becomes predictable and can be used first. “
While a 20-40bp annual loss is not huge, Kalesnik argued that it “can be 10 times the stated management fee” for an index tracker, with investors often switching funds in order to save a fraction. of this amount.
While the indices have little choice but to rebalance periodically, RA has made a few suggestions to reduce the impact.
Selecting additions based on their five-year average market capitalization can help avoid admitting “hot” stocks that turn out to be temporarily high-flying, while aggregation can limit “on-the-fly trades.” , additions that are quickly reversed.
Kalesnik said any investor able to delay trading for S&P 500 additions and removals for a year “may outperform the index.”
Alternatively, tracking an index that represents the entire universe of large-cap US stocks, rather than the “very narrow” S&P 500 avoids “entry point risk,” he argued.
Gareth Parker, former director of index research and design at S&P, who also worked with RA and is now president and chief index officer of Moorgate Benchmarks, considered that the selection methodology for the S&P 500, which includes the stipulation that a business must be profitable, was “not ideal”.
“It is essentially ‘active management’. They do not follow objective and transparent rules.
“The result is anomalies such as adding Tesla, and Google and Microsoft memory, much later than what would have happened if the rules had followed the normal add-by-size approach, subject to criteria of basic eligibility, ”Parker said.
However, he was not convinced by arguments that market cap indices “buy high and sell low” given that the track record of the S&P 500 “is remarkably good relative to active management, even before fees.”
Aye Soe, global head of commodity management at S&P Dow Jones Indices, said her data suggested what she called the “index effect” had in fact declined over the past decade, reducing losses from the market. rebalancing.
“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 criticize him, but if you look at active managers, most can’t beat him. “