Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The U.S. equity market, represented by the S&P 500 index, rose 4.5% this week.
  • The belief that indexes are passive representations of markets has been challenged this year by potential IPOs in the US and the changing composition of global markets.  

Privately-held SpaceX may file for an initial public offering (IPO) this year. Reports indicate that the company is aiming for a $1.75 trillion valuation by raising as much as $75 billion in the public stock market, or 3% of its purported total equity. Key players in the asset management world are jostling to position themselves for the listing.

Index providers are popularly conceived as stodgy, decidedly in the boring corner of the investment world. However, they are quite powerful entities. Inclusion of a stock in the S&P 500 or the NASDAQ-100 indexes means that “passive investors” who use index-tracking funds and ETFs will automatically invest in the newly included stock. Institutional investors commonly use these indexes to benchmark their performance, which will also draw capital to these names. Companies dream of inclusion in the big indexes.

A hangup is that the index providers have rules for index inclusion. For example, S&P Global requires that a company have positive earnings over the previous four quarters before they may be considered for the S&P 500.

Given the lure of including the SpaceX IPO – and the potential for additional gigantic IPOs this year from Anthropic and OpenAI – index providers are suddenly having a re-think about these pesky guardrails.

NASDAQ is considering including SpaceX stock in its indexes immediately upon its offering and including the listing at five times the market value of its freely tradeable shares. That would create huge indiscriminate buying pressure for the name, likely creating an artificial boost to performance. Jason Gay at the Wall Street Journal calls this overweighting “arbitrary, unfair and potentially risky for investors”. The NASDAQ-100 Index is the benchmark for one of the most popular ETFs on the planet, Invesco QQQ.

Quirks in the indexing world are appearing outside the US. MSCI is the industry-leading index provider covering global stock markets, whose classification of a country’s market as “developing” or “emerging” can result in massive shifts of investment capital across nations. Two countries that MSCI considers “emerging” – South Korea and Poland – have had incredible stock market performance in recent years. Korea’s market is up 120% over the 12 months, thanks to Samsung, and Poland’s three-year performance is the best in the MSCI’s emerging markets set, up 30% annualized.

FTSE Russell, MSCI’s main competitor in the global index world, considers these countries as “developed” rather than “emerging”. As a result, the FTSE Developed Markets Index is clobbering MSCI’s developed markets index, the EAFE, by almost 9% over the last year. MSCI’s Emerging Markets Index, conversely, is well ahead of FTSE’s Emerging Markets index.

These episodes are reminders that “passive” indexes are very much man-made. Although the moniker “passive investing” is associated with index funds and ETFs, differences in index composition and inclusion rules can create meaningful return variance over short timeframes.

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