Tesla (NASDAQ: TSLA) Always paid a lot of attention. Its groundbreaking electric vehicles have become a symbol of technological advancement, and the company that CEO Elon Musk has helped build a key player in its nascent industry has delighted shareholders this decade since its initial public offering (IPO) Have done
But for index fund investors, Tesla just brought the latest in a long line of controversies. That’s because index funds have spent just $ 90 billion to buy Tesla’s shares – and in just two days, they have already lost $ 7.4 billion to their fund shareholders.
Buy at an all time high
Index funds had known for over a month that Tesla stock was about to become a hot commodity. It was in mid-November that S&P Dow Jones announced that Tesla would join S&P 500 Index, Effective as of the commencement of business on 21 December.
This means that index funds had to aim to buy shares at the end of the day, around December 18. In this way, their returns coincide with the returns of the S&P 500.
However, unlike the index – which has the virtue of not actually implementing its investment strategy of holding around 500 constituent stocks – the funds had to figure out how to do all that while disrupting the markets as much as possible. This was a tall order, as Tesla’s market capitalization of over $ 600 billion meant that the electric automaker would represent a larger share of a larger multitrillion-dollar market.
According to S&P Dow Jones Indies analyst Howard Silverblatt, the index fund eventually paid out nearly $ 90 billion in Tesla shares. And as you can see in the chart below, on Friday afternoon there was a near-full-dollar price of $ 695 per share for Tesla’s stock that could pay those funds.
Hit $ 7.4 billion
On Tuesday afternoon, Tesla shares were trading at around $ 638 a share. That marked the second straight day of losses that rose by more than 8%. The $ 90 billion in stock that index funds bought late Friday was $ 7.4 billion less than the two days before.
As you can see above, the drop from high greatly resembles the mirror image of Tesla’s ascent before the index change takes effect. The effect of forced purchase of index funds is reflected in how the stock rose and the event declined.
Funds could do better
Worst of all, index funds were not supposed to take this financial hit. To put the stock’s moves into a slightly broader perspective, Tesla shares traded more than $ 400 just before the S&P Dow Jones Indics announcement. It took less than three days for the stock price to top $ 500 per share, and by the end of November, Tesla had climbed above $ 600 per share.
Broadly where Tesla’s share price stayed for the following few weeks. Yet in the final run-up to Index Inclusion, Tesla made another push. The last-minute spike did not make it past the $ 700 level, and it was so brief that it did not even appear on many intraday stock charts. But it was still the official final figure from which the performance of the S&P 500 would be calculated.
Why do index funds not care about you
The problem with index funds is that they have no incentive to avoid gamesmanship which inevitably leads to losses in this way. Most of the time, companies are too small to join the S&P 500, so the negative impact on shareholders is not as large as it was here. Nevertheless, this happens to some extent each time a new stock is included in the index.
Investors choose index funds only to track the index. When indexes create discontent in this way, fund managers blindly oppose their shareholders by following the rules.
Tesla is rooted for everyone now
Of course, given Tesla’s past performance, it is certainly possible that the stock will climb to $ 700 and beyond. This can happen today or even before the end of 2020. If this happens, everyone will be forgiven. And now Tesla is part of the index, this is what every index fund investor wants to see.
Yet for index investors as helpful as it is for general investors, this is the undiscovered price paid by index fund shareholders. In Tesla’s case, it took $ 7.4 billion out of their hands and put it in the hands of those who were not constrained by hard and fast investment regulations.