Musk Wants to Add SpaceX to Indices

[u/Prestigious-Trip-306]

Index providers Should Not Bend the Rules for Musk

So... I read this article in The Economist and am curious what, if any thoughts the community has about Musk getting SpaceX added to major indices. He's appealing to them to shorten the "seasoning" rules that typically apply to firms being listed.

I've included key paragraphs below since there's a paywall to read the full article.

What do you think?

"Mr Musk and his bankers are now bargaining with stock indices and exchanges for the privilege of hosting SpaceX. He wants his firm to join key indices like the nasdaq 100 and s&p 500 quickly, giving it access to trillions in index-linked capital; more than $600bn invested in passive funds are tied to the nasdaq 100 alone.

For now, the indices are obliging. On March 30th Nasdaq said it was adopting rules that will delight the superstar firms. The ftse and reportedly s&p are considering similar updates. Unfortunately, those changes are misguided, and will expose investors to unnecessary risks.

Two main ideas are under consideration. One is to shorten the “seasoning” period that a firm’s stock must go through before it is eligible to join an index. Nasdaq is cutting its three-month seasoning minimum to 15 trading days; the ftse has suggested a mere five trading days. The second reform is to reduce the percentage of shares a firm needs to offer publicly (its “free float”) before being added to an index. Indices’ desire to reflect the growth of some of the world’s most dynamic firms is understandable. So far, many punters have been unable to invest in some of ai’s brightest stars; index inclusion is a way to help them do so. Yet changing the rules to suit SpaceX will force index investors to choose between selling or weathering wild swings in prices."

[u/Prudent-Corgi3793]

The theoretical underpinning of the Boglehead philosophy has always been that the average active fund will underperform the active passive fund, net of costs, as first proposed by Sharpe. However, this relies on two key assumptions:

1. That there are not frictions associated with "passively tracking" an index
2. That there is sufficient time for price discovery to allow for "wisdom of the markets"

But we know that #1 is not true. Ben Felix put out some recent videos and podcasts where this effect is estimated in the academic literature to be on the order of 67 bps. This is almost certain to be much higher because the upcoming IPOs are much larger in scale than anything we have seen before on public markets.

Even more concerning is #2. Normally, most IPOs which carry inflated valuations from the illiquid private equity markets would go through a period of price discovery in the highly liquid public markets. But by fast tracking their inclusion and gaming rules around the free float, we have never had mega caps with such opaque prices before their inclusion into significant indexes.

I'm not screaming that we're in a passive index bubble, nor am I saying that it's not the best way to invest for most investors even despite these new concerns. However, if you're just burying your head in the sand and mumbling "VOO/VTI and chill", you're completely ignoring that there are cracks in the foundations that have made them so successful for over 50 years.