The Indexing Question: Should SpaceX, OpenAI and Anthropic be in the S&P 500?

[00:00:00]Hi, welcome back. The last few weeks, the talk of markets has turned to the three big AI companies that are coming into the market this year. The first of course has already made it SpaceX and I've talked about valuing SpaceX and the biggest part of SpaceX which is XAI at least from a value perspective in the coming months. Both OpenAI and Anthropic are also planning to go public with presumably trillion dollar valuations.

[00:00:29]And as we've discussed whether these companies are worth a trillion, two trillion or whatever they turn out to be, there's a parallel discussion that's been going on. And in this session, I want to talk about that parallel discussion. That discussion revolves around whether these companies should be included in the S&P 500. After all, the S&P 500 is about the 500 largest market cap companies in the US. And these three companies, without any question, will be in the top 10, let alone the top 500, the top 10. Now, most of the discussion seems to revolve around [clears throat] the fact that many people think they should not be included. And as I listen to the arguments, I'm skeptical. I'm skeptical because I see other agendas at play. Broadly speaking, there are three groups of people who seem to be arguing against the inclusion of these big AI companies in the S&P 500. The first group are active investors, institutional investors, mutual fund managers, and there, you know, these are of course people who've lost a bulk of their market share, a big chunk of their market share to passive investing. Much of the argument seems to revolve around how terrible passive investing is and how much risk this is going to expose passive investors to if it's included.

[00:01:53]So it's become basically a vehicle for active investors to argue about what's wrong with passive investing. The fact that these three companies can make it into the index. The second group are investment experts and academics. And their argument seems to be you don't know what you're doing. And this is directed at retirees and small investors. The worry seems to be that these investors will get blindsided if these three companies get included in the index. Blindsided how big money losing companies and the undercurren seems to be that they're overpriced.

[00:02:26]They'll be included in your index and over time you will suffer as a consequence. And the third group of people arguing against the index inclusion are effectively politicians saying that you shouldn't be including these three companies. But their reason is a much more simple one is that these companies are owned by founders who are going to become billionaires and billionaires are bad people and we shouldn't be rewarding by including them in the index. Now I'm willing to listen to these arguments but I want to step back from the brink and talk a little bit about how indices get constructed.

[00:03:01]what they're designed to do and how that that's changed over time and then directly confront whether these companies should or should not be included in the index. So let's start with how indices get constructed. When you look at an index, the first and most critical component is what are the constituents of the index. Let's take a couple of the best known at least in the US. You got the S&P 500 and any description of the S&P 500 will describe it as an index of the largest market cap companies in the US. Technically, that's not quite completely true, but that's what it's aspiring to do. The it's a it's an index of large cap US companies.

[00:03:44]The Dow 30, which has been around much longer than the S&P 500, is also an index of large cap companies, but it's only 30 companies. And by now, because of the age of the index and how things are constructed, nobody's quite sure how these companies end up there. It's opaque. You could take the indices run by the exchanges, the NYC, SEN, and the NASDAQ have their own indices. And over the last 30 or 40 years, the number of indices available for investors to follow has multiplied. Today, there are hundreds of indices just in the US. So, some are total market indices like the S&P 500 that cover the market. Some are indices that cover sectors. And if you go outside the US, there are indices for different geographies. The Sensex measures at least in in principle large cap Indian companies. The Bveesper measures large cap Brazilian companies and pretty much every foreign market there's an index measuring at least trying to measure how that market is doing. Now once you know what's in an index the second question to ask is how are those constituents weighted? There are three choices you have. The simplest is to equally weight every company. When you equally weight every company, the small companies essentially punch above their weight. So what you get as an index return will be skewed towards the smaller companies because you're taking the small company going up 100% the large company going up 10% and acting as their equivalent.

[00:05:19]The second approach to waiting and one that I've never quite understood but you find it in some older indices like the Dow 30 is price waiting. What's price waiting? You weight a company in an index based on its price per share. Not the market cap but the price per share.

[00:05:34]It's one reason if you look at the Dow 30 the two highest weighted companies are actually Goldman Sachs and Caterpillar and Microsoft is weighted far less. As I said it doesn't make sense but because the age of these indices you can't really change how an index is weighted late in its life.

[00:05:55]There's a third approach and this is the most common approach to creating indices. It is use market cap. Market cap is the total value of equity. Share price times number of shares with nuance. Nuance in what sense? Know there are some indices that use only voting shares. Some indices that are based only on traded shares. It's called float. The S&P 500 is a float adjusted market cap.

[00:06:18]Uses a float adjusted market cap weight.

[00:06:21]Which is one reason if you look at the weight of Meta or Walmart, it punches below its actual market cap because the entire market cap is not counted. So what is what's in the index? How is it weighted? And there are mechanical components that we need to think about when you think about why indices are where they are and how they change over time. First, when you look at an index, what exactly does that tell me about the companies in the index? If you look at the level of the index, let's take the S&P 500 on June 15th of 2026. The S&P 500 was at about 7,554.

[00:06:59]You say, "What does that mean?" It's a market cap weighted index. Is that the market cap of all the companies in the S&P 500? No, it's not. But it is related directly to the market cap. And here's how you go from the market cap to the level of the index. At the close of trading on June 15th of 2026, the float adjusted market cap, so basically it's the number of shares that are in the market that you can trade, market cap of the 500 companies, the float adjust market cap was about $63.5 trillion. So just add up the market cap of all the companies on a float adjusted basis. If you divide the index by the market cap, you come up with what's called index units.190.

[00:07:43]What does it mean by itself? It means nothing, but it's a conversion factor that gets used. So, if I told you that in the most recent year, companies in the S&P 500 paid out $300 billion in dividends and you wanted to convert dividends into index units, you would take the 300 billion and multiply by.190.

[00:08:03]Same thing with earnings. So, that index units allows you to go from these billions or trillions of dollars into numbers that are more manageable.

[00:08:12]If you have indices on assets that are not continuously traded with continuously traded assets like stocks and bonds, the index gets updated automatically because market price of every single asset in the index changes on a minuteby minute, hourby hour, day-to-day basis. But if you have indices of assets that are not continuously traded, things get messier in terms of measurement. Let's take real estate. Perhaps the best known real estate index out there is the S&P case shiller home price index. What does it measure? It measures what's happening to home prices by region of the country on a month by month, you know, quarter by quarter, year-over-year basis. You're saying, how do they come up with it since homes didn't don't get sold continuously? Here's what they do. They take all of the homes in their index and it's a sampling. Obviously, they don't include every home in the US. It'll be too many. a sampling of homes and then when one of the homes are so let's say you have a thousand homes in your index.

[00:09:14]One of the homes sold during a period and it went up 15% over a previous price. They adjust the pricing of all of the other non-traded components to come up with return. You can already see that indices of non-traded assets are noisier because you're making estimates of what the price is and there's often a lag in price price adjustment. What does that mean? When real estate values go down, it takes a little while for the index to reflect.

[00:09:42]Now, even the best constructed indices change over time. Why? Because companies get acquired, they they go bankrupt, their market caps decrease, and new companies enter the picture. You're saying, how do indices deal with it?

[00:09:56]Take the S&P 500. And this is very closely related to what will happen if and when the big, you know, the big new companies that are, you know, just outside the door come in to the market.

[00:10:09]I'm talking about Open AI and Anthropic and SpaceX. Let's assume that one of these companies is a trillion dollar market cap and S&P decides to add it to the index. First, it's 500 stocks. When you add a company, another company has to leave. Suppose a company that you're taking out has a market cap of a billion. You're replacing a $1 billion market cap company with a trillion dollar market cap cap company. If you just make that replacement and you don't adjust anything, your index will jump the minute you add the trillion dollar company. And that doesn't make sense, right? Not it's not like stock prices went up that day. See, so how do indices adjust for it? Through those index units. So if you take the the example that I just had, if on June 15th S&P decide to add a trillion dollar cap company and remove a billion dollar cap company, you're going to take the market value market cap of the entire index of 63,498.

[00:11:09]You're going to add the th00and billion, the trillion dollars, subtract out, so that's the added company. Subtract out the deleted company. the total market cap will go up but the index level will remain the same because you want the index to not change. The index units will change to point the index level will not change but remember when you replace a billion dollar company with a trillion dollar company even though the index is not changing you're changing the nature of the index. This is a talk for a different day. But if you look at the S&P 500, it's remained 500 companies for the last 50 years. But because of changes in the index, the characteristics of the index have changed in terms of growth and earnings and dividends. And that's that's something to think about when you look at these um investment strategies that look backwards at the index and say a 15 times PE ratio is high for the S&P 500.

[00:12:06]You're talking about an index that's changing over time. So index construction, index weights and index changes. Now all of this is leading in to a different question. Why do we have indices? And as I can see there are three big reasons. When I came into the market in 1981, the primary reason for having an index was to measure what the market was doing with one number because otherwise you have 500 companies moving or a thousand companies moving. You're trying to get a sense was yesterday a good day or bad day for the market. It's tough to make that judgment. It's a measurement device. And if you ask, is it a good measurement device? The truth is it depends on what you're trying to measure. If what you're trying to measure is the aggregate equity value in the market, you want an index with lots of companies weighted by market cap. The reason the S&P 500 has the standing that it does, it's the most widely tracked and followed index in the world is even though it has only 500 companies in a market that has thousands more, right?

[00:13:05]5,000 6,000 stocks in the US. Those 500 companies are the largest market cap companies. And the total market cap for the S&P 500 is more than 80% the total market cap of all US equities. So when the S&P 500 goes up 10%. Even though it's only 500 large cap companies, you're getting a pretty good sense of what the entire US equity market is going. But if you ask me, is that the best index? It depends on the question you're asking. Again, if your question is what did the average US stock do yesterday, looking at the S&P 500 might not give you the answer because it's weighted towards larger companies. An equally weighted version of the S&P 500, there is one out there, might be a better index to use. So, unless you know what you're trying to measure, you cannot really tell me what the best or the worst index is because the index measure is going to reflect the question you're trying to address. So, that's the first one. Over the last few decades though, starting in the late60s, indices have played a second role. In the late 60s, when they started, almost all of us gave our money as investors to professional money managers, mutual fund managers, pension fund managers. We assumed that they were professionals, so they would do better for us than we could on our own. And starting in the late60s the question that's been asked and deserves to be asked is are they are we paying for something that we get in return? Now the simplest proxy you can use to measure how an active investor is doing is to compare that active investor to the S&P 500 and it doesn't look good.

[00:14:47]This is a graph that looks at the percentage of large cap active funds that underperform the S&P 500 that do.

[00:14:57]So think of what you're doing. You're paying these fund managers to manage your money and most of them are underperforming the S&P 500. In fact, in the 25 years in this century, there have been only three years where more than 50% of active money managers have done better than the S&P 500 and it's barely above 50. If you look across the rest of the years, the numbers look absolutely abysmal. 70 80 even 90% of money managers underperforming the S&P 500. Now when these when these comparisons are made of course most active money managers say this is not fair I'm not a money man I'm not a fund manager managing something like the estimate I'm a value manager or growth manager so starting about 20 or 25 years ago there was a very simple alternative that both Morning Star and S&P used to judge those managers they said you're right you're a large cap value fund manager Instead of comparing you to the S&P 500, which is all large cap companies, what if we compared you to an index fund of large cap value stocks?

[00:16:13]And in this table, which is perhaps the most depressing table you can look at as an active money manager, I look at the percentage or this is actually from SPA, this S&P measure. They look at the percentage of active money managers broken down by investment style, large cap, midcap, small cap, value, growth, core, and they compare what these funds have made or they look at the percentage of the manager with of or percentage of managers in in each group that beat the index fund specific to that group. So let's take large cap growth funds in the most in the one year in 2025 95.5% 95.5% of active large cap growth funds underperformed an index that just bought large cap growth stocks.

[00:17:09]In fact, I've highlighted the greens are the only times or the only groupings where you see funds actually more than 50% of funds beating the index and they're few and far between and they're all in the less than five year phenomena. In fact, once you get to 10 years and beyond, there isn't a single group, not one, where more than 50% of active money managers beat the market. By the time you get to 20 year, more than 90% of pretty much every category, more than 90% underperform the index.

[00:17:46]I mean at this stage the question of whether active investing collectively does worth than putting your money in an index fund has been answered. You know, I think as as completely as it can be this it's no question collectively active investing is in shambles.

[00:18:06]Now, of course, if you're an active money manager, an active fund manager, you're going to look for hope. And you might say, well, there are subgroups where maybe people do better or maybe I'm special and see others bringing me down. But in the search for subgroups, I should also note that if you're in a different part of the world, you say it's different here. I'm in India. I'm in um I I'm in South Africa. It should be better. It's like India. This is the SPA has actually extended what it did in the US to India. And in India, you can actually see that it's the same phenomenon. 60% in short in the for the short term and 93% over the long term funds these indices b beat the market.

[00:18:49]Now you might say, well, I can't invest in the index. You can. In fact, that's the other part the the third component of indices that I think we need to emphasize. Indices started as measurement tools. They become became these performance evaluators.

[00:19:06]But in the 1976 at Vanguard, Jack Bogle, a man I respect immensely, he came to the he he came to the re recognition that active fund managers were taking your money and actually underperforming the index. And he said what if I could let people invest in the index directly. The Vanguard 500 index fund when it was started was the only index fund. But as you look across time the number of index funds has multiplied. Vanguard alone has more than 200 index funds and more than 100 ETFs.

[00:19:42]ETFs are variance in index funds on a variety of different indices. And the amount of money that's gone into index funds has also exploded in this century in particular.

[00:19:55]It's gone from being a sliver of total money invested to essentially the bulk of total money being invested or a big chunk of the total money being invested each year. So as you look at investment vehicles and you look at performance, you have these two forces coming together, right? Basically, you can see how badly your professional money manager is doing for you while you're paying him 1% of your wealth or you know 2% management fees and you have these vehicles where you can invest directly in the index. Doesn't take rocket science to figure out that the dam is going to break and it has. This is a graph that is that looks at the money under active investing versus the money under passive investing. Passive investing would be index funds and ETFs.

[00:20:46]If you look at 1998 99 the end of the last century active investing money was 10 times 15 times larger than money invested through passive vehicles.

[00:20:57]That's no longer true. In fact, by the time you get to 2024, if this were a boxing match, you'd call it off or any type of match, you'd call it off from you you'd invoke the mercy rule, which is say you can't allow this beating to continue. And if you look at the percentage of money that is now under passive in in passive investment vehicles, it's more than 60%.

[00:21:22]If this were a battle, it's been won by passive investing. And again, let's emphasize why it's been won. It's not that somehow active investors became worse in the century. They've always been bad, but their bad performance is now upfront and visible to everybody.

[00:21:41]And you also have created choices for investors where you say if you don't like what you what your active invest active money managers doing for you, here's a choice.

[00:21:51]So now we can look at the questions that have come out from the rise of passive investing. The first is if so much money is going into indices and in particular this relates to S&P 500 which remains the dominant index that index funds are it's not no longer the only one but it's still the dominant one. It's been this question that's been asked which is does getting added companies if a company gets added to the S&P 500 does it help the company and conversely the company gets taken out does it hurt the company and your first reaction is of course it's got to help the company you're making it into an index that is the most tracked and forwarded index in the world. It makes you more visible. Your liquidity should go up. And this isn't even bringing in the passive investing flows that might come from index funds.

[00:22:42]The argument has been around for decades that getting added to the S&P 500 should cause your stock price to go up and not just temporarily but permanently. And getting removed should make your stock price go down.

[00:22:56]The most comprehensive study I've seen of this phenomenon is actually comes from S&P. There are lots of academic studies that come to the same conclusion and here's what they all collectively find. First is most companies before they get added to the index see a runup.

[00:23:12]In fact, that's why you get added to the index. Your market cap went up enough that you become a large cap company.

[00:23:19]Conversely, most companies get removed from the index are companies that have done badly in recent time periods. So that's a pre-inclusion effect. Now if you look at the incl the the the inclusion itself and you look at the days before and after there is an inclusion bump that happens where when a company gets added its stock price tends to go up and a company gets removed or deleted its stock price tends to go down with a caveat.

[00:23:47]Much of that effect seems to have dissipated over the last few decades. In fact, if you just take the last 20 years, you can't reject the hypothesis that getting added to the index has no effect on your stock price. Though getting deleted or removed from the index still has a negative effect, though less negative than it used to be.

[00:24:05]Now, for those people who argue that passive investing is this awful phenomenon that will make you being in the index, you know, be a huge bonus.

[00:24:15]This cuts against that argument, right?

[00:24:17]Because as you've seen the growth of index funds and passive investing, getting included in the S&P 500 has become less powerful than it used to be.

[00:24:29]Some of this can be explained by the fact that you now have hundreds of indices, every companies in some index.

[00:24:35]And the second is by the time a company sees its market cap rise to get into the index, you're already visible in the world we live in because information and data is so easily accessible. You could argue the effect of getting out of the index has a lesser effect than it did.

[00:24:54]There's a second argument and this cuts to oh incidentally while we're talking about index inclusion and I know there are people who are waiting for you know SpaceX to get added to the S&P 500 and they're asking the same question about open AI and Enthropic expecting a bonus of some sort when that happens. I would caution you and I would suggest you look back at what happened when Tesla got added to the index towards the end of 2020.

[00:25:23]Remember, by the time Tesla got added to the index, it was already an incredibly large market cap company. S&P had kept putting it off and off for a variety of reasons, some good, some bad. And finally, on December 18th of 2020, Tesla got added to the index and it replaced AIV. It's a real estate company that fallen in market cap.

[00:25:47]This graph looks at what happens to Tesla and AIV in the months after the SNP inclusion of Tesla Tesla and the AIV exclusion. Remember, if inclusion is good news, you'd see Tesla go up and AIV go down. But what you see in the aftermath is actually the reverse. Tesla was down more than 10%.

[00:26:11]AIV was up 60%. In fact, Tesla underperformed the index. I'm not suggesting this means that if SpaceX gets listed, it stock price will go down. I'm just saying that there is no magic bullet here. Getting added to the index might not have any effect on these companies.

[00:26:28]There's a second argument and this is really a much broader argument against passive investing and here's how it goes. Let's assume that most investors are passive investors and that assumption seems to be well well supported. The argument here is when or much of the money comes in through index funds, there's going to be a momentum effect. It feeds the momentum effect.

[00:26:52]And here's why. Let's assume a $100 billion of cash enters the market. And it all enters into index funds. Who's going to get most of that cash? Let's make that index fund a very specific one, the S&P 500. A big chunk of that 100 billion is going to go to the largest market cap companies. Why?

[00:27:11]because indices are market cap weighted.

[00:27:14]So basically the argument is passive investing is going to make large companies more valuable, push up the pricing because the momentum is going to make funds flow into them. By the flip side of that, it also means if the funds flow from other companies, smaller companies, less followed companies will become less valuable. So there'll be a redistribution of pricing from small cap to large cap companies if the bulk of the indexing is on large cap indices.

[00:27:43]At the same time, the argument is because momentum becomes a stronger force, there'll be more of a disconnect between prices and fundamentals.

[00:27:51]Seems pretty reasonable, right? In fact, the people making this argument will point to multiple things happening in markets that support or at least consistent with this argument. First they'll note that markets have become topheavy and they have right the big winners at the top the mag seven in the last 10 20 years have carried the market. The second is the small cap premium or small cap stocks under higher return than large cap stocks of an enduring phenomenon of the 20th century seems to disappear. And third momentum effects seem to dominate fundamentals.

[00:28:26]So if you classify stocks in momentum for much of the last 20 years, the highest decile of momentum stocks have been the best performers, it's not the highest desile of fundamentals.

[00:28:38]I am skeptical and I'd like to push back because I I there are people I respect who make this argument and my three push backs against the argument are the following. First, momentum is based on fund flow. And it seems to be built on the presumption that fund flows are always positive. But are they? Can't funds flow out of markets? And if momentum causes positive fund flow to push up the price of the largest market cap companies, shouldn't funds flowing out of the market cause the effect in reverse? In fact, the largest market cap companies should be the ones that drop the most. In other words, if you believe that there is a momentum effect, it'll show up more in the volatility of these large cap stocks and there is actually some evidence of increased variance standard deviation volatility of companies exist in the index.

[00:29:33]On the second phenomenon, have markets become more topheavy? Absolutely.

[00:29:39]Now, that could be because of momentum, but I'll give you an alternative argument. If it's entirely due to momentum, here's what you should see.

[00:29:47]You should see these large cap companies. The price earnings ratio, EV to EB, you pick whatever pricing metric, they should disconnect from small cap companies. Small cap companies should be should be dirt cheap on price earnings ratios, EVITA.

[00:30:03]You don't see that. In fact, if you look at where the earnings growth for this market has come from for the last 20 years, it's come from the large cap companies. If prices have increased, they seem to be reflective of the fact that earnings at these large cap companies have grown up grown much more than small cap companies. And I think there's an economic story here which is if you look at what's happened especially with disruption in technology over the last 25 years a lot of businesses have gone from being splintered advertising car service you name the business hospitality to becoming essentially winner take all businesses with two or three big players control the big chunk of the market in advertising which used to be a hopelessly splintered business. It's Google and Facebook and I'm using their old names that dominate the advertising business. What does that mean? You're you're going to have businesses with two or three winners. Of course, you should see that reflected markets. And thirdly, you know, the presumption here is if you let passive investing kick in and fundamentals, you know, and active investing gets pushed out, nobody's minding the store. In what sense?

[00:31:18]Nobody's collecting information.

[00:31:19]Nobody's doing research. And if you carry this to its endgame, markets will become completely inefficient. The argument then is that you know passive investing is driving out the people who make markets efficient. I would love to go along with this, but I've seen a lot of active investing and equity research and I think the notion that they somehow do serious research and unearth and for most there's some who do but most are are basically know herd followers. They there's no original research or seeking information. In fact, I'll wager there are as much momentum players as the average trader. There's a subset of active investors who actually do research or contribute to make making market prices more informative. And guess what? Those will survive. In my view, passive investing is not going to become 100% of investing. It might end up at 60 65 70%. But it is absolutely true that active investing going forward will be a much smaller but a more value adding business where the people who are left are people who actually bring something to the table.

[00:32:37]But let me concede that it could be true that maybe passive investing is making markets more inefficient.

[00:32:44]I'm not sure what to do with that though. Are you telling me that retirees and individual investors should therefore continue to use fund managers even though these fund managers deliver returns lower than the index and the larger cause of making markets more efficient? I mean are you out of your mind? That's completely tonedeaf.

[00:33:07]I am a retiree. I'm setting setting aside money to cover my waning years. I want to make get the best return I can and not pay 2% of my money every year to a manager who does nothing for me.

[00:33:22]Maybe maybe and this could be true.

[00:33:23]Maybe this argument is directed then at regulators asking them to rein in index funds by doing what? By restricting the indices that you could create index funds on but restricting the size of index funds. You know who this is going to be great for? Active investors because now the money has to come to them. But let's be honest that if that's the reason you're pushing it, it's to protect your own jobs as active investors, as fund managers. Don't talk about, you know, retail trying to protect individual investment retirees.

[00:33:55]They're not even in your frame of reference.

[00:34:00]So that's the second component. Now, let's look at the third component of passive investing and why some experts and academics suggest that this could be dangerous. Again, a lot of there there seem to be a lot of empathy, at least in the opinion pieces, for the small investor. Here's how the argument goes.

[00:34:21]that if S&P opens the doors and includes a company like SpaceX in the index that there'll be hundreds, thousands, millions of retirees who put their money in an S&P 500 index fund who are now exposed to hidden risk because they don't know that SpaceX SpaceX has entered the index. And second, they don't know how much money it's losing.

[00:34:45]And they also don't know that SpaceX is overpriced at least according to these experts. So their argument is that allowing these large companies which are money losing to enter the index is bad for individual investors because left to their own devices individual investors would not retire invest in these companies. You know what? I've heard versions of this argument for the last 20 years where people have argued that the MAG 7 and big tech companies should not be included for a variety of constraints. Can you imagine what your returns would have been if you'd invest in the S&P 500 and it had not included the MAX 7? I mean I think it's insulting to individual investors first that you know to act like they would not know that SpaceX is in the index and second do you really think that you know individual investors are going to say I don't want to be in SpaceX maybe they want to be in SpaceX. Now if you want to make this argument there's a more nuanced way to make the argument. Maybe there's a subset of individual investors, deeply risk averse people who don't want money losing companies in their index and may I'm sure there's an index out there and I could find you one or the S&P 500 could create an index of the 500 largest market cap companies that make money and have established business models and offer it as an alternative to these investors.

[00:36:10]maybe they will they will buy in and then they can pick something that reflects it. But I don't quite get why this you know why this is an argument you can make for not including SpaceX or OpenAI anthropic in the S&P 500 as an index that investors across the board invested.

[00:36:30]Now finally on the on the question of you know of endowment funds state you know controlled endowment funds that might choose not to invest in index funds because they include SpaceX or OpenAI anthropic you know or perhaps because they're they're owned by by billionaires you don't like there's a fiduciary responsibility you have right so when you're Kalpers or the New York pension fund it's not your money you're investing it's not politician money it's the money of employees of the state put their money aside in this fund and you've now decided for whatever reason that they should not be investing in things you don't like. There's a lawsuit coming your way if that's your thinking.

[00:37:11]But ultimately, I think when you look at the arguments against including large market cap companies in the index, they they fall apart when you start pressing on them. Now, all of this, of course, you know, is um is is is something to think about, but I think that as you look at investment experts and academics making this argument that you need protection for retailers and individual investors, there are three things I think they seem to either forget or not quite get. First is, is SpaceX a risky company? Absolutely. And if you put your money in SpaceX and four other companies who were still to just in SpaceX, you're extraordinarily exposed to that risk.

[00:37:56]But if you put it into the S&P 500, one of 500 companies, let's give it a market weight, you know, based on its float, it's probably going to be 3 4%. I would argue that that investor is better positioned than one an active investor who decides to invest in SpaceX because he thinks it's cheap or an active investor chooses not to invest in SpaceX because he thinks it's expensive or she thinks it's expensive and the company ends up going up.

[00:38:28]I would argue that the way markets have evolved, it's actually more dangerous for investors who actively pick to be or in out of these stocks than it is to actually invest in the index. Second, implicit in this trying to protect retail investors and retirees is this delusion that there's smart money and stupid money or smart money and naive money.

[00:38:56]You know what smart money is, right?

[00:38:57]It's usually hedge funds and private equity and all these smart guys out there.

[00:39:03]And stupid money is the rest of us. We are uninformed. We're knive.

[00:39:08]I have for 40 years I've been looking for smart money. I haven't found it. Be quite clear. Much of what is labeled smart money behaves exactly the way funds do when compared against alternatives.

[00:39:20]The average alpha alpha measures how much how well you do against the market.

[00:39:24]The average alpha for both private equity and hedge funds is negative. But you know what? This notion of smart and stupid money sticks around because it's convenient for both sides. The smart money likes to be labeled smart even though it's not smart. You know why?

[00:39:40]Because it allows them charge 2 and 20 or insane fees.

[00:39:45]You say, "Why would the stupid money want to be labeled stupid?" Because you can then blame somebody else for mistakes you make.

[00:39:54]I'm struck by how many individual investors who've screwed up by making active choices blame hedge funds for where they are.

[00:40:03]You know, I talked about this before about not being smart that money should be divided into humble money and arrogant money, not smart and stupid money. So, I think the belief that individual investors can't make choices on their own is insulting. And finally, the notion that a big money losing company with a bad business model has to be a bad investment as opposed to a big money-making company with stable earnings being a good investment is widely held, but it's absolutely wrong.

[00:40:37]Can you have a money-making company be a bad investment? Yes, at the wrong price.

[00:40:43]Can you have a money- losing company be a good investment? Absolutely. If it's priced right.

[00:40:48]This notion that you can step in and remove companies that you think are bad companies comes from this misconception about or mixing up what a company is from what an investment does. In fact, I'll make a wager and I plan to test this out in the coming weeks. If you created an index of companies in 2001 that was restricted to only money-making companies with nice business models, I will wage that index would have significantly underperformed an index that didn't have that constraint. Just went out and bought the 500 largest money m the 500 largest market cap companies. So I think that much of the advice that is being meed out here is being meated out by people who don't seem to understand fundamentals in investing but still call themselves investment experts.

[00:41:41]Now all of this argument and I started writing this post and I started thinking about it a few weeks ago. There was still this question of whether SpaceX would be included in the S&P 500. In fact, at that time the assumption was, hey, this is a big company. S&P is going to weaken its rules because S&P has very specific rules in place on what you need to be in the index. A company has to have a float that exceeds 10%. Has to have made money in the four quarters leading into the index and have a large market cap. And you know, people assume they would not change the rules because they would want it in. And S&P I think surprised a few people by announcing the week before the IPO that they would not include they would not change those rules which effectively means that SpaceX is not even going to be considered to be included in the index for at least the next 12 months and at the end of 12 months it's not guaranteed it will be because it might not be making money.

[00:42:43]I think it was the right decision for S&P to make because changing the rules for individual companies sounds craving.

[00:42:52]I do think they need to revisit those restrictions in the long term. The float restriction I I get I know you don't want a stock like a Ramco where only 2 or 3% of the stock is listed and traded to be in an index if people can't buy the index. So if you want to put a 10% 15% 20 whatever the float restriction is talk among yourself and make a reasonable judgment I can I get that the money losing I just don't get I mean you can be a large market cap company with immense potential the fact that you're losing money shouldn't restrict you in fact can you imagine if SpaceX Open AI and Anthropic don't make money for the next 5 years but see the market cap go from a trillion to two trillion how can you as S&P 500 call yourself an index of 500 largest market cap companies if those trillion dollar companies are not in there but for the moment the choice has been made and S&P might frame it in terms of we did this because we want to protect individual investors we're doing but the reality is they're doing this because this is going to be one of the most incredible adjustments S&P's ever had to make talked about the Tesla adjustment and it took them a long time to make that adjustment, adding it to the index. Can you imagine doing what you did with Tesla multiplied by six or eight when you think about the three large companies and trying to include them all in the index in the same year?

[00:44:21]Now, if if S&P is doing it because they think a year from now, you know, the problems they see are going to resolve themselves, that there's going to be more float and better governance and making money, it's not going to happen.

[00:44:33]these companies a year from now are going to be just as messy. So, it's a transition that and I understand that it takes a while to bring in these companies and it takes it makes sense for S&P to stagger them up. You say, "What about the companies themselves? If I were running SpaceX or OpenAI and Anthropic, I frankly don't care whether I'm in in the index or not." You think, but being in the index helps you remember the study, you know, the the evidence on what's happened to me. I'll wager and this is a an impossible wager to test because you both paths can't happen at the same time. If these companies were included in the index, their price behavior or the price the endgame would be exactly the same if they were not included in the index.

[00:45:21]If this were a bargaining question, I think that the index needs S&P needs SpaceX open athropic to be in the index more than the companies need to be included in the index because they're going to be fine either way. And as for these debates, I'm sure you will see more of them in the weeks and months to come. But I would [clears throat] take a step back because as I said there's lots of agendas at play and for many this becomes um a tool to essentially advance their agendas.

[00:45:57]I hope you found the session useful and I thank you very much for listening.