https://www.wsj.com/articles/why-tesla-was-left-out-of-the-s-p-500-11599579707?st=x50z71e7aylivut
adding share token link to avoid paywall
I believe you were also thinking about index arbitrage when you posted this?
Yup, Index arbitrage opportunities & risk from high impact points of
failure. The two are related.
My previous understanding for inclusion into the S&P 500 was a
pre-determined set of criteria on a fixed schedule. Did not know that an
8-person comittee decided which companies >$11 trillion of funds track and
when they'd get included into the index.
This is concerning and requires further investigation.
Yes, it is concerning. It seems easy to make money by buying just before inclusion and then sell. Infact this seems to be what a lot of folks are doing. TSLA crashed after it was announced that it won't be included.
As the market is zero sum in the short term, that gain would come at the cost of normal investors who are passively investing in S&P. If the share price of new companies drop right after joining S&P(due to arbitrage selling), then that will push the return of S&P lower.
VTSAX should be immune to this though.
Yeah, I'd posted about this Index arbitrage mechanism way back in https://panchayat.haletic.com/#91
Why should VTSAX be immune to arbitrage?
Also need to look at the inclusion criteria for the CRSP U.S. Total Market Index that VTSAX tracks
Cooking up an example:
Say you have 100K invested in SnP index fund. And at time t TSLA joins the index. At t-δ, you will have 0K invested in TSLA. At some time arnd t, Vanguard will start buying 1K(1% weight going by today's market cap) TSLA for you.
But right after that, TSLA would drop by say 10% with all the arbitrage selling. So you lose $100 to arbitrage.
For VTSAX, everything is same except the company would be "A1 Quality Paper Clips" entering the index at 0.0001% weight. The loss to arbitrage would be proportionally only 1 cent. I was handwaving through the example. Do you see anything wrong in my understanding?
Now large private companies that IPO might enter with heavier weights and cause greater losses. But that arbitrage can only be leveraged by private investors. And, that already happens when founders get to cash in large sums right after IPO. We just don't call it arbitrage.
Oh yeah, the impact on a single stock joining a broader index like VTSAX will be lower than it would be on something relatively less broad like S&P500.
For VTSAX, the transition/discontinuity boundary should be when a company goes public or dies or gets re-privatized (is that even a thing?). For S&P, there exists another discontinuity boundary of when a company becoming big.
If you know when a company is going to go public, you have the same kind of index arbitrage opportunity on CRSP US Total Market based funds as you have on an S&P500 based index fund. The discontinuity would be less intense than it'd be for the S&P500 for sure though.
Note:
- A company can be private and huge, e.g Public sector Oil&Gas enterprises.
- The numbers may not be as low as in your example, given that they're market weighted and market weights of stocks on the index are more exponentially than uniformly distributed.
For S&P, there exists another discontinuity boundary of when a company becoming big.
The only discontinuity boundary in SnP is when the company becomes big. Going public should have no implication for SnP?
A big company going public should impact both the S&P500 and VTSAX.
Going big impacts the S&P500, going public can impact both
or gets re-privatized (is that even a thing?
I remember Michael Dell taking Dell private.
Oh yeah, the impact on a single stock joining a broader index like VTSAX will be lower than it would be on something relatively less broad like S&P500.
The main difference is that most stocks joining VTSAX, join when they are very small. Hence the impact is negligible. If a big private player IPOs like you mentioned Aramco etc, then you have the same impact as SnP. Still massive private company joining VTSAX can only be arbitraged by private equity investors.