By Suzanne McGee, Lewis Krauskopf and Anirban Sen
NEW YORK, June 15 (Reuters) - Last week's stock market debut of Elon Musk's SpaceX is forcing providers of equity indexes to reconcile two often-conflicting objectives: Do they stick to their inclusion rules or revise them to reflect changes in the market they are targeting?
Financial advisers and asset managers agree that both goals can be in the interests of investors – but navigating the tension between the two requires forethought about the risk
tolerance and appetite for volatility implicit in indexing decisions that have often been presented as one-size-fits-all.
“The IPO is the headline, but the real story is about index methodology,” said Dina Ting, head of global index portfolio management at Franklin Templeton. “Investors should pay attention … because what you actually own depends on whether you’re buying this index versus that index.”
The mega-IPO wave kicked off by SpaceX and expected to continue this year with AI favorites Anthropic and OpenAI may force reassessments of which indexes give investors more of the risk profile they seek, investors and indexers say.
For the time being, decisions at Nasdaq to quickly add SpaceX to its signature Nasdaq 100 index and at S&P Dow Jones Indices, which oversees the benchmark S&P 500, to hold off will likely add to the Nasdaq’s reputation as a favorite of those willing to accept big price swings as part of the tab for potentially large gains.
“You're going to get very different experiences because all of the indexes made a bunch of active decisions about which stocks to include, when to include them, how much weight to give them,” said Joel Schneider, deputy head of portfolio management at Dimensional Fund Advisors, an investment firm that bills its approach as “going beyond indexing.”
Schneider said the wave of mega IPOs “is causing advisers and investors to start to pay more attention to some of these decisions and how they are made and what they mean.”
RUSH TO JOIN MAJOR INDEXES
In the months before its listing, SpaceX sought to accelerate its addition to major indexes including the S&P 500, the most widely tracked U.S. index, and the Nasdaq 100, long a showcase for the most powerful U.S. technology firms.
Investors buy mutual funds and ETFs that mimic these indexes to get broad exposure, such as the Invesco QQQ ETF for the Nasdaq 100 and the State Street SPDR S&P 500 ETF.
"I think the most aggressive investors have for years been shifting their focus to the QQQs rather than the SPY. The decision by the different index providers will further that trend," said Eric Kuby, chief investment officer at North Star Investment Management Corp.
In changing its rules to add SpaceX within a month of its listing, the Nasdaq returns to its roots in promoting high-flying firms that in some cases have not generated strong financial results. Were Anthropic and Open AI to also list on the Nasdaq, it could highlight a valuation disconnect in U.S. markets last seen in the 2000 technology bust.
MEGA IPOS OFFER GLITZ, RISK
S&P 500 index funds with trillions of dollars in assets would have been forced to buy up SpaceX shares had rules been changed to admit it to the index. There are $3.2 trillion of assets under management in the three largest ETFs tracking the S&P 500, from Vanguard, Invesco and State Street, compared with around $600 billion of assets in the largest Nasdaq 100 funds.
The decision by the S&P 500 not to immediately add SpaceX and similar firms potentially creates a path on which the returns generated by giant indexes diverge even more than they have in recent years, creating a dilemma for investors who may be drawn by the glitz of AI-related offerings but who question the risk of trillion-dollar-plus IPO valuations.
“In general, if you're sort of more risk-on, if you would, then obviously the QQQ has the ability to include companies that are not profitable,” said King Lip, chief strategist at BakerAvenue Wealth Management in San Francisco. “Risk-off market, you're going to have the S&P probably going to do better from an overall perspective."
Schneider said research published this month in the scholarly Review of Asset Pricing Studies shows that fast-tracked IPOs outperform their non-fast-tracked counterparts by 5 percentage points through the date of index inclusion – but that the shares give back more than half of those gains within two weeks.
To be sure, S&P 500-linked funds still have heavy exposure to technology stocks and to AI-linked trends that have helped drive markets higher, and also could make them vulnerable in the eyes of some investors.
“Obviously, the early inclusion of some of these companies into the indices is a change, so people that have been investing passively are going to find themselves arguably with riskier portfolios than they were historically,” said short-seller Jim Chanos, who has warned that the SpaceX offering is fueled by "hopes and dreams" that do not justify its valuation. “And the AI bull market — to the extent there's anything systemic, it's just that equity portfolios have gotten a lot riskier.”
(Reporting by Suzanne McGee, Lewis Krauskopf and Anirban Sen in New York; Writing by Colin Barr; Editing by Matthew Lewis)
