Revisiting Tesla’s Addition to the S&P 500: What’s the Cost, Before and After?
We have observed that additions and deletions to the S&P 500 Index follow a dependable pattern: additions underperform and deletions overperform over the subsequent 12-month period. The December 2020 rebalance out of AIV and into TSLA lived up to this pattern rather spectacularly—at the six-month mark, AIV has a relative return advantage over TSLA of 78%!
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 December 2020 S&P 500 rebalance out of AIV and into TSLA cost investors 41 bps in the first six months, and the cost may go higher. Smarter index design and more-efficient implementation could help investors’ tracking traditional indices avoid these hidden costs.
We and others have often observed a pattern in additions and deletions to the S&P 500 Index: typically additions underperform and deletions outperform the index in the subsequent year. The larger the addition to the S&P 500, the larger the average gap in subsequent relative performance. It has happened yet again with the addition of Tesla (TSLA) and the deletion of Apartment Investment and Management (AIV). In early December 2020, in our article “Tesla, the Largest-Cap Stock Ever to Enter S&P 500: A Buy Signal or a Bubble?,” we made the additional point that Tesla already sported bubble-level valuations, priced at more than 120 times when compared to the traditional automakers on a per car basis. Historically, companies at bubble valuations significantly underperform the market… eventually.1 Taking these two observations together, we predicted that AIV would outperform TSLA, perhaps by a stupendous margin because of Tesla’s scale and valuation levels.
Tesla entered the S&P 500 on December 21, 2020. Six months after the fact, what has happened? AIV outperformed TSLA by a stupendous margin.
Index funds are often thought to be passive. Not entirely—stocks are added and dropped, and rebalancing trades are made as company float changes. Although turnover is low, that turnover follows a consistent pattern: index funds systematically buy high and sell low. The recent addition of Tesla to the S&P 500 near its highest-yet valuation levels is a striking confirmation of this pattern. As the following chart vividly shows, our expectation of underperformance by TSLA and outperformance by AIV, as we stated six months ago, was right on target. As of the close on June 18, 2021, AIV has delivered 60 cents on a dollar invested compared to TSLA’s loss of 10 cents on a dollar invested, a relative return advantage for AIV of 78.6%.2