By Michael Wursthorn and Gunjan Banerji
Additions and subtractions to the S&P 500 are normally a
ho-hum affair. The 509th biggest company in the U.S. might jump to
497th place, and thus into the index. Investors who track it buy
the one stock and sell another.
But no one has ever tried to add Tesla Inc., a $555 billion
company prone to huge swings in price. That's happening next month,
and it's causing headaches across Wall Street.
To avoid missteps, S&P polled big investors on whether they
would prefer adding Tesla's weight all at once on Dec. 21 or split
over two trading days in December -- an unprecedented move for
S&P.
Asset managers and trading desks across Wall Street have held
virtual summits to debate the matter. The vote from many appears to
be for the two-day option, partly because of Tesla's size, along
with the potential for elevated volatility in the stock market.
"If we begin to anticipate a worst-case scenario from what could
happen from the Thanksgiving holiday, we could expect greater than
usual volatility," said David Mazza, a managing director and head
of product at exchange-traded-fund manager Direxion, referring to a
possible further surge in coronavirus cases. He endorses Tesla's
addition to the S&P 500 over two separate trading sessions.
Tesla's addition to the index is expected to be particularly
challenging because the company will be the largest to ever join,
and it is expected to make up at least 1% of the gauge. At its
current value, it would be the sixth-largest company in the S&P
500, just bigger than Berkshire Hathaway Inc. and smaller than
Facebook Inc.
The stock, which has a cultlike investor base, has surged more
than 40% to $585.76 since Nov. 16, when S&P announced its
intended inclusion, extending its gains for the year to sevenfold.
The S&P 500 itself is up 13% in 2020.
The decision rests with S&P, which said it intends to
announce results of the consultation on Monday. Regardless of the
outcome, investors and traders expect the market for Tesla shares
to heat up even further ahead of the inclusion. Goldman Sachs Group
Inc. predicts shares will eventually touch $600, a 2% gain from
current levels, by the time Tesla joins the index.
Tesla's inclusion is expected to put more than $100 billion into
motion. Index funds will have to sell smaller stocks already in the
S&P 500, somewhere between $60 billion and $80 billion
depending on Tesla's market cap, and use that money to buy shares
of the car maker, asset managers and traders said.
Actively managed funds benchmarked to the S&P 500 are
projected to buy $8 billion of Tesla shares, Goldman said in a
recent note. The move will also spur trading within separately
managed accounts that use the S&P 500 as a benchmark, as well
as hedging activity by trading firms that buy and sell ETFs.
Those sums are big, but investors say Tesla's addition to the
index would normally be manageable in a single day. Shares of Tesla
are widely traded, with daily volumes reaching as high as nearly
$65 billion in mid-July, suggesting there is enough liquidity to
cover the trade.
The trade date, Dec. 18, coincides with a once-quarterly event
known as quadruple witching, the Friday near the end of each
calendar quarter on which options and futures on both indexes and
stocks expire simultaneously. Volume is usually heavy on those days
and would help boost liquidity on the day of Tesla's inclusion,
investors said.
They said the curveball is accounting for other potential
volatility in the stock market tied to Covid-19 or signs the
economic recovery is faltering. The market has been particularly
rocky this year. There have been more single-day stock moves of at
least 3% for the Dow Jones Industrial Average, S&P 500 and
Nasdaq Composite than in any year since 2008.
Investors who had shared their opinion with S&P have offered
another suggestion that appears to have earned broad support:
breaking the trades up over two different quarters, according to
people familiar with the discussions.
A longer break between the trades would help asset managers
digest any sharp moves related to Covid-19 or other news the market
doesn't take well and help keep funds in line with benchmarks,
investors said.
"A stepped approach over multiple quarters helps with the
liquidity challenges. There's good precedent for it," said Chris
Johnson, head of ETF capital markets at Charles Schwab Corp.,
referring to MSCI's two-phased inclusion of China A-Shares to its
emerging-markets index in 2018.
There are also concerns that the flurry of buying that comes
with index inclusion will temporarily drive up Tesla's share price
for firms forced to buy around the addition. That means the stakes
are high for S&P and index funds, which account for about 41%
of the assets that track the S&P 500.
"The people who will pay the price if S&P screws up are the
investors in passive S&P" funds, said Ben Inker, head of asset
allocation at investment manager GMO, which oversees about $60
billion in assets.
If the huge burst of demand ahead of inclusion disappears,
Tesla's shares could fall dramatically after they join the gauge,
he added.
Timing is hard for investors and indexers alike. Yahoo's market
capitalization peaked less than a month after it was added to the
S&P 500 in December 1999 -- just before the burst of the
dot-com bubble. Qwest Communications' market cap peaked the same
day it was added to the index in July 2000. Neither stock trades
today.
"Why am I the sucker who has to buy it after the stock is up
fivefold?" is what one might wonder if forced to buy Tesla shares
after such a tremendous run-up, said Mike Bailey, director of
research at FBB Capital Partners, which oversees some Tesla
shares.
Write to Michael Wursthorn at Michael.Wursthorn@wsj.com and
Gunjan Banerji at Gunjan.Banerji@wsj.com
(END) Dow Jones Newswires
November 29, 2020 05:44 ET (10:44 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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