Tesla will finally join the S&P 500 index on December 21, 2020.
In September, Standard & Poor’s announced that the index’s inclusion committee had decided No. To add Tesla to the S&P 500
Given Tesla’s perfect size – it is now among the 10 largest U.S. firms by market cap – and the ubiquity of the S&P 500 in portfolio and retirement accounts, we wanted to know what the risk and return of the index might be at the beginning of Calendar 2020 if the company was included.
What we got in the first 11 months of 2020 can be summed up fairly briefly: bigger incomes, bigger instability.
The S&P 500’s return will increase 1.21% in those 11 months. It returns 14.78% with Tesla and excludes 13.57%.
But there is a downside.
Tesla’s single volatility was 110.11% when we measured monthly earnings over the period. So adding this single stock to the S&P 500 will increase the overall volatility of the index from 26.98% to 27.35% in the first 11 months of 2020.
The question is: were those increased returns worth the extra volatility?
With the incorporation of Tesla, the sharp ratio of the S&P 500 will increase from 0.499 to 0.537, taking a risk-free rate of 0.30% during this period.
Tesla and S&P 500 returns
It is important to note two caveats. First, our investigation is a matter of forward bias. In order to include Tesla in January, the S&P 500 Inclusion Committee had to relax its standard requirements so that companies could make four-quarters of the profit before adding. And Tesla stock prices have risen nearly 700% this year. So in our study some level of cherry picking is to blame.
Second, the S&P 500 owns the free float weighting methodology and the dividers used in its calculations, which are compatible for stock splitting, consolidation and other events. Since we lack access to this data, we estimated our actual weight adjustment to the best of our ability.
We replicated the weights on a float-adjusted basis (quarterly) and saw that Tesla would weigh 0.26% when joining the index in January and 0.71% by June’s restructuring.
That being said, it seems that if Tesla had brought in an increased volatility index, investors would have made their decisions based on sharp ratios.
However, when Tesla joins the index, it will mean a huge jolt for the S&P 500 and all stock weights. In fact, if Tesla were to be re-admitted in the fall, it could be the first company to make its S&P 500 debut weighing more than 1%.
So we can expect a significant impact on portfolio and retirement accounts later this month.
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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
Photo courtesy of NASA