The S&P 500 committee announced recently that Tesla is going to be added to the S&P 500 index, one of the largest stock market indices in the world. What does this mean for you? Well, if you currently invest globally using index tracker funds, it means you’re probably about to become a Tesla shareholder, whether you like it or not!
When it comes to investment strategy, there are two main schools of thought. The first is what’s known as 'active management'. This form of investment is what usually comes to mind when thinking about investing in shares. Active management involves actively looking at the companies on the stock market and seeking to find those that will provide better value than the market average over the long term.
There are a number of different approaches to this, but it essentially comes down to the belief that a skilled investor or investment manager can conduct analysis and make choices that gives them the edge over the market as a whole.
The other main form of investment is what’s known as index, tracker or passive investing. Those that believe in this form of investing feel that the stock market is efficient, and that it isn’t possible to utilise skill and research to ‘beat’ the market.
In order to achieve the market average return, passive managers will buy the ‘whole market’. So for example, if you wanted to buy the US market, one of the most common ways is to buy an S&P 500 index tracker fund. This fund will invest in all of the companies in the S&P 500, automatically, regardless of what is going on with the world or with any of the individual companies included.
Tesla is a great example of where this could potentially be a problem.
Unlike many of the world’s largest stock market indices, being a big company doesn’t automatically garner inclusion into the S&P 500. Yes, being a large, valuable company is part of the criteria, but Tesla has met the benchmark for size (or market capitalisation) for some time now. As well as market cap, the S&P committee also consider area such as profitability of the company and how easily its shares can be traded.
Profitability is thought to be one of the main reasons for Tesla being snubbed in the previous quarters, having been passed over for companies including online retailer Etsy and Pool, a wholesale distributor of pool and spa supplies!
So the S&P 500 committee have obviously had some concerns over Tesla shares in the past, but once they are added to the index on 21st December, passive investment managers the world over will be required to purchase Tesla stock.
This is a key issue for investors. I’m not making comment in this article as to whether Tesla shares are a good buy at the moment or not, but passive investors also aren’t going to be able to make that distinction within their investment portfolio.
That isn’t to say that passive investing doesn’t make sense in certain circumstances, because sometimes it does. However as an investor, it’s important to understand that by investing passively, you are giving complete control to the market, and sometimes a committee, to decide what sits inside your portfolio.
If you’d like to discuss in more detail what’s inside your investment portfolio, and whether it’s right for you, please get in touch for a no-cost, no-obligation discussion.
The information given and opinions expressed are subject to change and should not be interpreted as investment advice. All data is sourced by IM Asset Management Limited unless otherwise stated. All financial and wealth management services are provided by IM Asset Management Limited which is regulated by the Financial Conduct Authority (FCA), FCA Firm Reference Number 402770.
"If you currently invest globally using index tracker funds, it means you’re probably about to become a Tesla shareholder, whether you like it or not!"