Bloomberg Businessweek - USA (2020-08-03)

◼ FINANCE Bloomberg Businessweek August 3, 2020

23

*VALUE

OF

AVAILABLE

SHARES

AND

ESTIMATED

WEIGHTING

AS

OF

JULY

28
CLOSE.

DATA:

S&P

DOW

JONES

INDICES,

BLOOMBERG

earnings,Teslajustcrossedthatline.

Thepossibleadditionofthecarmakeris a big

eventformanagersofindexmutualfundsand

exchange-tradedfunds.They’realready hash-

ingoutstrategiesforoneofthebiggestpotential

tradingchallengesthey’vefacedinyears.Tesla

wouldbethelargestcompanyindollartermsever

addedtotheindex,whichmanagersof$11tril-

lionofinvestmentseithertrackreligiouslyoruse

asa benchmark.AtthecurrentpricesofTeslaand

otherstocks,managersofpassivefundswillhaveto

sellabout$35billionto$40billionofsharesinthe

restoftheindex’scompaniestomakea holebig

enoughtofitpurchasesofTeslashares,according

toGerryO’Reilly,a principalandportfoliomanager

atindexinggiantVanguardGroupInc.“Assuming

it’sgoingtobeadded,it’llbeanall-hands-on-deck

typeoftrading,”hesays.

There’snotemplatetofollowforVanguard’s

twodozenU.S.traders—plusa teamofanalystswho

workonkeepingtransactioncostsdown—whenit

comestoefficientlyhandlinga stockasbigandvol-

atileasTesla.Norisit easytopredicttheripple

effectsintheoverallmarket.

The shiftin theindex composition could

beannouncedanytime.Theadditiontheoreti-

callycouldhappenalongwiththedeparturesof

E*TradeFinancialCorp.orTiffany& Co.,which

arebeingacquired,oraspartofa routinequarterly

rebalancinginSeptember.

Indexfundsmaygetasfewasa coupledays’

noticeoftheswitch.Sotheyneedtodecideif they

shouldstartbuyingbeforetheaddition,thedaythe

stockis tobeadded,orafterward.Pickingwhich

approachisn’tassimpleasit sounds.WhileTesla’s

stockmaybebidupbytraderstryingtotakeadvan-

tageofdemandfromindexers,otherinvestors

maytreatit aswhatO’Reillycallsa “superliquidity

event.”Thatis,longtimeTeslashareholderswhoare

lookingtotrimpositionsmaytrytogetoutwhen

theyknowindexfundshavetobuy.Thetwokinds

ofinvestorscouldcanceleachotherout.“There

areallsortsofcrosscurrents,”O’Reillysays.Hesays

he’sconfidentVanguardwillbeabletohandlethe

switchwithouta major“trackingerror”—thatis,a

dislocationbetweentheperformanceoftheindex

andthefundsthatfollowit.

LikemanythingsaboutTeslaChiefExecutive

OfficerElonMusk,hiscompany’spathintothe

S&P 500 isunconventional,whichexplainshow

Teslabecamethegorillaintheroomfortheindex

fundcrowd. Investors simplybelieved inthe

Teslastoryenoughtobidthesharepriceintothe

stratosphere despite a record dotted with more quar-

terly losses than profits. The S&P 500 is weighted by

market capitalization—with the most highly valued

companies taking up the largest share of the index. If

that were the only standard, Tesla would have quali-

fied awhile ago. The threshold to be added is a mar-

ket value of a little more than $8 billion.

The committee that decides the membership of

the S&P 500 is keeping mum about when—or even

if—it plans to add Tesla. “Companies who  meet

the eligibility requirements are not automatically

added to the index,” said a S&P Dow Jones Indices

spokesman in an emailed statement. “They join a

pool of other eligible candidates and are consid-

eredforinclusionwhenanopportunitypresents

itself,atwhichpointtheIndexCommitteetakessev-

eralfactors into account such as sector balance and

size representation.”

When figuring out how to weight companies in

theindex,theS&Padjuststheirvaluetoreflectthe

numberofsharesavailablefortrading.Usingthat

standard,Teslawouldlikelybethe16th-largest

company in the S&P 500 if it were included now,

with an index weight of about 0.8%—between Pfizer

Inc. and Verizon Communications Inc. One of the

largest additions to the benchmark in recent his-

tory occurred a decade ago with Warren Buffett’s

Berkshire Hathaway Inc., which at the time had an

adjusted market value of $127 billion, far less than

Tesla’stoday.Butit representeda biggerweightin

theindexthen.

Whileindexersstrategizeabouthowtohandle

this shake-up to the passive investment world,

traders with a more active approach will be trying

to figure out how to profit from price swings cre-

ated by the potential announcement. “The trade

would basically be buy Tesla, sell everything else,

and you’d start to see that in the market,” says Steve

Sosnick, chief strategist at Interactive Brokers.

Still, it’s possible that expectation is priced into

Tesla’s shares after a gain of as much as 293% this

year. A working paper posted by the National Bureau

of Economic Research in July titled “Does Joining the

S&P 500 Index Hurt Firms?” found that stock pops

linked to the announcement of index inclusion have

gone away, and the lasting effect on price in recent

years has been downward. Since Tesla reported its

earnings, its shares have fallen 7.3%. “Firms included

in the index perform extremely well in the year

before they are included in the index,” says René

Stulz, a professor at Ohio State University and one

of the paper’s authors. “Our results would also imply

that getting into the index would not lead to another

boostinTesla’sstockprice.”�SarahPonczek

THE BOTTOM LINE If Tesla joins the S&P 500, managers of index

funds are going to have to sell tens of billions of dollars of shares in

other companies to make room.

1.3%

1 .1

0.9

0.7

▼ Largest additions

to the S&P 500 since

1993 by value of

shares available for

public trading

Index weighting

at addition

Tesla*

(not in index)

219

Google

79

Yahoo!

92

Qwest

95

Berkshire

Hathaway

$127b

Bank of

America

93

JDS Uniphase

127

UPS

75

Philip

Morris

108