SpaceX Offering Is First Test of New Index Fund Rule
Rules, rules, rules. I have spent my entire career in a world of rules. If I do a rudimentary assessment of the regulatory bodies asserting authority over the business of financial advice, I can count five; there are probably more, all of them have rules.
I have also spent a considerable portion of my career performing supervision and compliance functions in my firm, which is a fancy way of saying “rule enforcement.” I believe in the rules; some are really smart, some not so much, all have a purpose and solid intention.
Rules also evolve over time. Technology changes, standards evolve, and regulators react. Sometimes faster than others, but ultimately the market for services determines regulatory focus, and regulatory focus determines rules. And the rules have just changed again.
By the time you read this column, the largest initial public stock offering (IPO) in history will be in the rear-view mirror. Even those who do not pay daily attention to financial markets will likely be aware that Elon Musk’s space technology company SpaceX is now a public company. Because I write this column on Tuesday morning, and SpaceX will not begin trading until Thursday, it is impossible for me to know at this moment how the process played out, but the one thing I am sure of is that it will be huge news.
Commenting on SpaceX as an investment opportunity is beyond the scope of this column, but there is no doubt the company, by its very nature, represents a version of humanity’s future that I, and most of the people I talk to every day, find irresistible. By now, most of us have seen the video online of SpaceX’s scissor tower catching a giant rocket in midflight, pulling it down to the launch pad and gently setting it down for refitting. This concept alone makes SpaceX impossible to ignore, and the world is justifiably captivated by this company.
Whether, however, investors find the crazy level of hype around the stock offering, the science fiction component to the company, or the credibility of Elon Musk himself enticing, recent financial industry rule changes are likely to make this company more relevant to many investors than they might believe. Let’s go over why.
Investors participating in their employer’s 401(k) plans (or 457 or 403(b) plans for certain types of jobs) are likely to gain exposure to SpaceX through their plans without realizing it.
Employer-sponsored retirement plans provide investment options to their participants primarily in the form of mutual funds.
All mutual funds consist of large baskets of diversified stocks and/or bonds combined to create an easy-to-invest-in portfolio for investors. In this regard, there are two primary “flavors” used to select underlying portfolio holdings. These two different flavors are referred to as active and passive.
With an actively managed mutual fund, the underlying portfolio's holdings are selected by human fund managers or human fund management committees.
Index funds are built differently. With an index fund, the fund’s stocks and bonds are not selected by a fund manager; they are selected by an index provider. An index is a basket of stocks or bonds assembled to represent a certain segment of the financial markets. The index provider is most often a third-party entity that then licenses the index to mutual fund companies, which then select portfolio holdings with the intention of mimicking the target index. A primary advantage of index funds is they typically involve lower internal investment management and trading costs.
Due to these lower costs, most retirement plan sponsors (employers) include index funds in the funds offered to participants (employees), either through individual fund options or by embedding them in “target date” funds designed to provide turnkey investment allocations to employees.
This common adoption inside retirement plans is a primary force driving the reality that index funds now represent 55% of all mutual fund assets and include eight of the top 10 largest mutual funds in the U.S., which to me, is more and more begging the question: Just what are these indexes made of and who decides how they are built? Back to the rule change.
Until recently, index providers did not include newly offered stocks like SpaceX in indexes. All providers required a “seasoning” period, which enabled the hype and volatility that often surrounds initial offerings (IPOS) to subside. This practice, required by various financial industry rules, appears to me to be based on the intention to maintain the “credibility” of the indexes created by providers. Broad-based indexes are designed to represent markets, not to enable speculation, and IPOs were considered just too speculative.
So why the change? Well, I am speculating here, but clearly American corporations, particularly technology companies, are aware of the massive amount of capital invested in index funds, and they very much want access to some of it. As investing styles have changed, it has become much easier to simply lobby for rule changes by index providers than it is to attract capital from individual investors and fund managers.
I haven’t formed a resolute opinion on these changes yet, but the question I keep asking is this: Are the rules being changed for the benefit of investors, or the benefit of the corporations wanting easy access to capital? I think we’ll find out soon enough.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
