What Tesla's inclusion in the S&P 500 means for investors

-- | 21/12/2020

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Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Tesla has been added to the S&P 500, triggering the largest rebalancing in the index's history. Joining me today to talk about what the addition means for the index and for index fund investors is Ben Johnson. Ben's Morningstar's global director of ETF research. Hi, Ben, thank you for being here today.

Ben Johnson: Thanks for having me, Susan.

Dziubinski: Let's talk a little bit about how the Tesla addition ranks in the history of additions to the S&P 500.

Johnson: The Tesla addition is going to be the single largest addition to the S&P 500 in that index's history. In fact, it might actually be one of the single largest equity trades in the history of the stock market. Where it ranks is, if not at the top, very near the top, which is why you see so much attention around this, which is all incremental to what we've just seen, all the hype around this stock now going back years. We're at a point now where the stock is up more than sevenfold on a year-to-date basis. Its market cap is over $600 billion. It's going to land somewhere around number six in the rank order of the largest constituents of the S&P 500, which in and of itself is one of the largest, most widely followed indexes on the planet. There are trillions of dollars that are either looking to directly track the index or are otherwise benchmarked to it. So, this is a big deal.

Dziubinski: It's gotten a lot of media attention, but what does it mean for an everyday investor that this stock is now going to be a substantial part of the S&P 500?

Johnson: Well, it's a great question. For most investors, what I would say is that it's not going to be that big of a deal either in the moment or long term as it pertains to the performance of an S&P 500 index-tracking ETF or fund that they might own in their portfolio. There is going to be some degree of performance effect for that stock as you see hundreds of billions of dollars traded in it to bring it in to the index, whether that pushes the price up, whether it brings it back down. What we've seen over time is that because these events are so widely publicised, because these stocks and these benchmarks are so widely followed, that index-inclusion effect is really diminished over time. And when you frame it in the long-term performance of whatever the benchmark in question might be, it really doesn't have all that big of an effect.

Now, if investors are concerned about this effect, which could well prove to be detrimental in the near term and slightly longer term, what I would suggest is to just invest in index-tracking products that are underpinned by more broadly diversified benchmarks. So, if you look at the Vanguard Total Stock Market Index Fund, which itself passed a major milestone in recent weeks crossing a trillion dollars in assets under management, that particular fund is underpinned by the CRSP US Total Stock Market Index. That index has owned Tesla for quite some time now and sweeps in almost the entirety of the investable market capitalisation of the US stock market. So, what you do is, as you widen out, as you own a bigger underlying benchmark, is you minimise these potential pain points, these potential friction points that are created by either regular rebalancings or, in this case, a reconstitution - the biggest addition in the world of indexes in history.

Dziubinski: There has been some negative talk specifically about those investors who own an S&P 500 tracking index fund about what impact this Tesla addition is going to have. Should these investors be concerned?

Johnson: If they're concerned, it should be to the extent that they're late to the game relative to investors in other index products that are tracking, as I alluded to before, more broadly diversified indexes, those that capture the full spectrum of the investment opportunity set in US stocks. In this particular instance, I'd be hard-pressed to argue that they're getting a bargain here with the Tesla addition. Our own equity analyst, Dave Whiston at Morningstar, would probably back me up on that. We have a 1-star rating on the stock at the moment, indicating that we think it's quite overvalued. So, this is an instance where index investors, investors in S&P 500 index products as a whole are very likely buying high.

Dziubinski: Ben, thank you so much for your time today and your perspective on this event. We appreciate it.

Johnson: Thanks so much for having me.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.

This report appeared on www.morningstar.com.au 2022 Morningstar Australasia Pty Limited

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