24 November 2020
An unexpected frisson of excitement ran through passive investment managers. Admittedly, this was unusual and heady stuff for a profession that prides itself on staying well within its rules and, some might say, a little dull.
There is one issue in investing that seems to divide opinion more than any other, and the passive managers found themselves right at the heart of the debate.
Tesla: you either love it or hate it, it seems.
Suddenly, one of the most talked-about companies and stocks in the world was getting very interesting to passive fund managers. The announcement came on Monday 16th November, when the committee which determines the companies that make up the S&P 500 index took the decision to add the $420bn market-cap carmaker to the widely-tracked index. It will represent the largest-ever addition to the index. Additions happen fairly often, but just aren’t anywhere near as high profile. September’s addition of Etsy, health tech company Catelent and electronic tester Teradyne passed with much less fanfare.
Why had this not happened earlier?
It might be surprising that what was then the 15th largest company in developed markets by market capitalization hadn’t already been added to one of the world’s most significant indices, but there is a little-known fact about inclusion in the S&P 500 and that is there are criteria for profitability as well as just size. Stocks need to show four consecutive quarters of profits, and this is what has held Tesla back up to now. Even then inclusion boils down to a quarterly committee decision – Tesla had met the profitability criteria back in September but the committee took the decision not to add the stock in the last reshuffle.
However, other index providers do not have this criterion and this is where things get interesting. The indices most widely followed by UK investors: the MSCI World and FTSE World have included Tesla for years with Tesla joining the MSCI World in 2013. So if you invest passively in global equities you have likely had exposure to Tesla for years, today at around 0.75% of your portfolio – so you can congratulate yourself on participating in all the gains Tesla has enjoyed.
What does this announcement mean?
Tesla stock jumped on the news – at the time of writing it is up over 25% since the announcement (and is now up to the 7th largest stock in the developed market indices), but this news had also been anticipated for months, and perhaps contributed to the spectacular rise we’ve seen in the share price of over 400% so far in 2020. Tesla has been a stellar performer over recent years, experiencing double-digit gains in 5 of the last 10 years, and triple-digit gains twice.
But most UK passive investors will have already been investing in the stock – and participating in these gains since Tesla entered the global indices in 2013.
A question many are asking though is – have all the gains been made, and are S&P 500 index fund owners being sold an overpriced stock?
It’s a possibility of course but you might remember there were similar concerns about Facebook in 2013 and that worked out pretty well for index investors.
So, should passive investors care about Tesla being added or not?
In short, no.
Tesla may or may not be overvalued, but that’s no different to the other thousand or so stocks in a typical passive portfolio. By going passive you are making a decision not to worry about the potential outlook for every single stock in the portfolio (or more accurately , to let others worry about their value , and trust they will get it about right). Sure, some companies will do very badly and lose almost all their value. Some will do spectacularly well and drive most of your gains. Index investing is all about a numbers game and not about worrying about every single stock in the portfolio. And remember, from a UK perspective, investors have already enjoyed the strong returns that Tesla has had over recent years.
So, whether the world’s most controversial stock continues to fly along in the fast lane, takes off, goes into reverse, or crashes completely, passive investors can sit confidently in the passenger seat without worrying – a strategy that has been extraordinarily successful and hard to beat over the last decade. The Tesla bears and bulls will debate the merits for ever, leave them to it. It takes two views to make a market as they always say.
If you would like to hear more thoughts on growth investing from an industry expert and Tesla “bull” check out our podcast with Charles Plowden.