Tesla will finally join the S&P 500 Index on 21 December 2020.
Back in September, Standard & Poor’s announced that the index’s inclusion committee had decided not to add Tesla to the S&P 500. This unexpected news sent Tesla shares tumbling more than 16% in one day.
Given Tesla’s sheer size — it is now among the 10 largest US firms by market cap — and the S&P 500’s ubiquity in portfolios and retirement accounts, we wanted to know what the risk and return implications for the index would have been had the company been included at the start of calendar 2020.
What we found over the first 11 months of 2020 can be summed up quite simply: Greater returns, greater volatility.
The S&P 500’s returns would have increased by 1.21% over those 11 months. That equates to a 14.78% return with Tesla and 13.57% without.
But there’s a downside.
Tesla’s stand-alone volatility was a whopping 110.11% when we measured monthly returns over the period. So adding this single stock to the S&P 500 would have increased the index’s total volatility from 26.98% to 27.35% over the first 11 months of 2020.
The question is: Would those increased returns have been worth the extra volatility?
With Tesla included, the S&P 500’s Sharpe ratio would have risen from 0.499 to 0.537, assuming a risk free rate of 0.30% over the period.
Tesla and S&P 500 Returns
Two caveats are important to note. First, our investigation is subject to look-ahead bias. For Tesla to have been included in January, the S&P 500 inclusion committee would have had to relax its standard requirement that companies achieve four straight quarters of profitability before being added. And Tesla’s stock price has risen around 700% this year. So our study is guilty of some degree of cherry picking.
Second, the free float weighting methodology of the S&P 500 and the divisor used in its calculations, which adjusts for stock splits, mergers, and other events, is proprietary. Since we lack access to this data, we approximated our actual weighting adjustments to the best of our ability.
We replicated the weightings on a float-adjusted basis (quarterly) and found that Tesla would have had a 0.26% weighting when it joined the index in January and a 0.71% weighting in the June reconstitution.
All told, it looks as if the increased volatility Tesla would have brought to the index would have been worth it if investors were basing their decisions on the Sharpe ratio.
Whatever the case, when Tesla does join the index, it will mean a huge shake-up for the S&P 500 and the weights of all stocks. Indeed, had Tesla been admitted back in the fall, it might have been the first company to make its S&P 500 debut with a weighting greater than 1%.
So we can expect a sizeable impact on portfolios and retirement accounts later this month.
If you liked this post, don’t forget to subscribe to the Enterprising Investor.
All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Image courtesy of NASA
Derek Horstmeyer
