S & P's determination so as to add Tesla suddenly reveals the facility of passive investing


Tesla Motors CEO Elon Musk responded after the company went public on the NASDAQ market in New York on June 29, 2010

Brendan McDermid | Reuters

Standard & Poor's actions on Tesla demonstrated the growing power of indexers and passive investments.

S&P Dow Jones Indices announced that Tesla will be added to the S&P 500 in a single promotion, using the December 18th closing price.

S&P surveyed large institutional investors to see if Tesla should be added in one fell swoop – at the end of December 18, a four-fold expiration date, and traditional daily stocks are being rebalanced in the S&P – or whether it should be broken into several separate trading days are split.

The concern: Tesla's inclusion in the S&P that day will create a lot of trading volume and pressure on various stocks.

This concern is justified given the size of Tesla.

This will be the biggest realignment of the S&P 500 in history.

How large? Very large.

Tesla's current market capitalization is $ 546 billion. However, due to Elon Musk's stake in 20%, the stock will be included in the S&P with a weighting of 80%, or about $ 437 billion.

Approximately 17% of the total value of the S&P 500 is tied to passive index investments that would require the purchase of approximately $ 72 billion worth of shares on the day of settlement.

To buy $ 72 billion, you have to sell $ 72 billion. That's a lot of money and a lot of pressure. By comparison, the total realignment of the S&P last quarter came to $ 32.4 billion. The highest all-time high was in September 2018 when it was $ 50.8 billion.

S&P asked the trading community how best to do this: should it all be in one day of balancing (December 18th – when the greatest liquidity is in) or should it be spread over a few days?

The benefits of one day are that the rebalancing has massive liquidity. The downsides are that it can put downward pressure on the stocks being sold, which can lead to order imbalances.

In theory, changing the weight of a stock in an index shouldn't change its price, as nothing fundamental is happening. However, this would be the biggest realignment in history, and no one is entirely sure how it might turn out.

Ultimately, S&P decided to rip the plaster off and do it all at once.

This shows the power of indexers. The true amount of money indexed directly to the S&P 500 is likely much higher than the official figure of around 17%. There are many who do not officially license the index but "emulate" it by purchasing most of the components.

Nobody knows exactly how big this shadowy community of Closet Indexers really is, but it is certainly not unreasonable to expect an additional $ 30 billion to $ 50 billion in additional purchases on top of the $ 72 billion from Official could "indexer.

That's buying a lot.

Subscribe to CNBC PRO for exclusive insights and analysis as well as live business day programs from around the world.


Katherine Clark