The company Tesla (TSLA) booted from the S&P 500 index has vastly outperformed the electric automaker by a “stupendous margin,” analysts at Research Affiliates pointed out this week.
Tesla entered the S&P 500 to great fanfare on Dec. 21, 2020, in a rebalance of the index. It surged well over 20% in its first month, but since then has fallen, standing now with gains of about 5%, lagging the S&P 500’s (^GSPC) near-16% gain in that same timeframe.
Tesla’s entry meant one company had to leave, as the S&P 500 does not become the S&P 501 when a new company joins the club. To make room, S&P had to kick out Apartment Investment and Management (AIV) from the index, but since that December 2020 rebalance, the company’s stock spiked almost 60% — and though it went down still stands around 40% higher than it did when it got the boot.
According to analysis from Research Affiliates' Rob Arnott, Vitali Kalesnik, and Lillian Wu, Apartment Investment and Management, this pattern is not uncommon. Frequently, additions to the index underperform and removed companies often do very well, the authors wrote in a research note.
"Traditional cap-weighted indices routinely buy high and sell low when the index rebalances resulting in substantial hidden costs to investors who track the index,” the note said. “The December 2020 S&P 500 rebalance out of AIV and into TSLA cost investors 41 [basis points] in the first six months, and the cost may go higher.”
In their view, a struggling stock getting kicked out of the index during a rebalancing means getting the axe at a low point. On the other side, a hot new stock getting added to the index is trading at a high point.
The authors pointed out that though index investing is passive, the actual indexes aren’t necessarily passive as the decisions on which companies to include in the S&P 500 is controlled by a committee. And the index changes to compensate for companies’ valuations and new entrants periodically, not automatically.
An investor who had $100,000 in, say, an S&P 500 index fund on Dec. 21 when the rebalancing happened would be $410 poorer had no rebalance happened, Research Affiliates calculated.
"Unfortunately, this cost is totally unnoticed by investors because it is baked into the index’s performance,” the authors wrote.
The analysis suggests these are hidden costs of indexing and Tesla’s underperformance and Apartment Investment and Management’s outperformance should have come as no surprise given historical patterns. But of course, there was no guarantee this time was going to be like the previous ones.
But if you think this pattern could be a consistent one, the paper’s authors believe there’s an opportunity to innovate.
“Smarter index design and more efficient implementation could help investors tracking traditional indices avoid these hidden costs,” they wrote.
That may not happen, so they propose another option: If you’re not just an index fund buyer, try doing the opposite of what the index does.
“The index rebalance is a great opportunity to do the opposite of what the index does: buy the deletion and sell the addition,” the authors wrote. “Providing index investors liquidity and benefitting from the mean reversion of the price changes has historically proven to be an excellent investment idea.”
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Ethan Wolff-Mann is a writer at Yahoo Finance focusing on consumer issues, personal finance, retail, airlines, and more. Follow him on Twitter @ewolffmann.
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