The U.S. stock market is on a tear higher. Ever since the recovery from the March meltdown, the capital keeps pouring in the market, with many names making new all-time highs.
Tesla is one of them. Viewed as more than just a simple electric car company, Tesla benefits from investors’ climate change fears and is a darling stock among the younger generation. However, the numbers behind the company do not justify the current valuation. But there is one thing that keeps driving investors to Tesla – passive investing.
S&P 500 Inclusion and How Could Tesla Benefit
Active investing refers to fund managers actively buying and selling in order to beat a benchmark. Typically, the benchmark is an index, like the S&P 500. Their success or failure to beat the index marks their performance.
Passive investing, on the other hand, tracks the benchmark. For example, passive investing managers build portfolios similar to the index and do not alter their composition.
However, when the shares of a new company enter or exit an index, all passive investing managers buy or sell the shares in the new company. Tesla fits the criteria needed to be included in the S&P 500 index after the Q2 2020 earnings.
From that moment on, speculation began of what will the price be if the passive investing managers start buying Tesla shares for their portfolios in order to match the new S&P 500 composition? According to some estimations, there need to be approximately 25 million shares purchased for such a move to happen. At the current price for the shares of Tesla, we talk about tens of billions of USD.
The problem is that the S&P 500 inclusion announcement, if and when it comes, will also trigger the selling of shares in the index funds to have the capital for buying Tesla. Moreover, there is no way how to know when and if the process already started.
For example, such an announcement will likely have an immediate positive response in the market. Shares of Tesla are expected to react positively. Therefore, the ones owning the shares will stand to benefit the most.
Speculators always try to get ahead of the market, and positioning for the announcement may be the reason why Tesla shares remain bid on every pullback so far.