Passive is Massive so Tesla got dumped. How is index investing distorting markets?
Tamas Calderwood is a Distribution Specialist at eInvest. Prior to this Tamas spent almost a decade working for MSCI (often pronounced "misky"). They are responsible for constructing some of the world’s largest indexes (indices - what's the correct word?). Passive fund management has evolved from the fringes of the financial world to the dominant position it now occupies in Australia and across the world.
There are currently over 7000 ETFs trading worldwide packaging a multitude of asset classes. They are both actively and passively managed. These funds can be a broad like the ones that track the combined indexes of the largest markets in the world, to themes as specific as cybersecurity and healthcare. What differentiates them is not the way they are packaged but rather the way they are managed.
Tesla and the Observer Effect
Tesla would be the largest company ever to be added to the S&P 500 if it was to be added to it in the future, which with its market capitalisation and ability now to generate consecutive profitable quarters seems likely. Currently there is an estimated $11 trillion tracking the S&P 500 in the US making up over 40% of all equity ownership and half of this $11 trillion is investing in passive ETFs representing around $5.5 trillion. Tesla if added would be 1% of the weight of the index, representing around $55 billion which passive funds would need to invest in Tesla, whether they believe it is worth the price they purchase it at or not.
Passive investing has become such a force in the market that it has now become possible to speculate on the inclusion of Tesla in the S&P 500 and the surge in demand for its shares which would be generated by this news. Evidence of this is the 21% collapse in its share price after the S&P 500 passed over adding it to the index in September. Passive index investing has grown to the point that the act of benchmarking against the market is having an effect on the market.
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This post was incredibly well-researched and written by Hayden Toohey. Hayden's a student at UTS and an intern at the Australian Shareholders' Association. I predict that he will be running the Reserve Bank within a couple of years. Here's a link to his LinkedIn profile if you'd like to get him before the Reserve Bank does.
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