The trillion-dollar IPOs are coming. A case for staying passive.

Passive investing is valued for its simplicity and low costs. In times of high IPO activity, the valuations being thrown around can make some investors feel dizzy. When a company goes public with a valuation in the hundreds or thousands of billions, index providers are under pressure to include it quickly to maintain market representation – and the stock indirectly ends up in your own portfolio.

Historically speaking, every IPO is a «wild animal» in its own right. It's impossible to predict how trading will unfold after the offering or the best time to buy.

Among the indices likely to include these new listings sooner or later are the MSCI and Nasdaq indices, as well as the well-known S&P 500. As for the timeline of index inclusion and market weight, the indices differ significantly from one another:

• S&P 500: With over $13 trillion in assets under management now tracking the U.S. index, it is the giant in terms of market capitalization. Inclusion in the index is likely to trigger the strongest mechanical buying effect. In addition, S&P is considering shortening the IPO observation period from twelve to six months.
• Nasdaq: With over one trillion dollars in tracked assets, the index family is no lightweight, but it is an order of magnitude smaller than the broader-market S&P 500. The deadlines for inclusion in the Nasdaq-100 have been significantly shortened. For example, a mega-cap can be included in the index as early as 15 trading days after the IPO. It is also reported that Nasdaq has relaxed the minimum free-float requirement to facilitate the IPO of Elon Musk’s SpaceX.
• MSCI: The total value of assets invested directly via the MSCI USA, along with the U.S. allocation within global MSCI indices, also exceeds the trillion-dollar mark. Large-cap companies typically enter the early Inclusion track and are included approximately ten trading days after the IPO. Smaller companies fall under the standard review, which takes place quarterly.

When determining the index weighting of a new company, S&P and MSCI base their calculations on free-float market capitalization rather than total market capitalization. This means: If a company goes public with a market capitalization of $2 trillion and the free float is 5 percent, the index weight is $100 billion.

The situation is different for the Nasdaq-100: For weighting, total market capitalization is used rather than free-float adjusted market capitalization. For companies like SpaceX, which allocate less than one-third of their shares to free trading, the index weight is capped at three times the free-float market capitalization.

All in all, we expect the S&P 500 to generate the strongest buying pressure, followed by the Nasdaq and MSCI. In terms of timing, it is likely to be exactly the opposite.

It is also certain that certain special effects come into play with every IPO. These include the ending of the lock-up period for existing shareholders as well as specific bets speculating on inclusion in an index. A good example is Tesla: Although its IPO took place ten years before its inclusion in the S&P 500 was announced in December 2020, inclusion in the index triggered high demand. Since ETFs and index funds tracking the S&P 500 had to buy the stock in proportion to its weighting, Tesla’s share price climbed by around 70 percent in the run-up to the inclusion. ETFs alone purchased Tesla shares worth around $90 billion.

Why the choice of index matters

When choosing an index (and thus an ETF), potential conflicts of interest with other business areas must be considered in addition to market weight. The Nasdaq is a stock exchange that benefits directly from the volume and prestige of its high-profile listings. The situation is similar at Standard & Poor’s: the corporate group also includes a dominant rating agency. MSCI is also profit-oriented, but does not operate a stock exchange or rate credit; instead, it provides indices and market data.

The MSCI USA is only slightly broader in market coverage than the S&P 500, but the difference compared to the Nasdaq is significant. On the Nasdaq, the weight of a single company can be the highest. This is due, on the one hand, to the heavy weighting of technology stocks and, on the other hand, to the fact that index inclusion is generally based on total market capitalization.

At True Wealth, our philosophy is to remain committed to a passive investment approach while also taking into account the impact of mechanical buying. That is why, where appropriate, we rely on the MSCI USA Index.

For clients with a sustainable investment universe, we focus on the comparatively strict SRI equivalent. Of the three major IPO candidates, Anthropic – now that the company is no longer permitted to work with the U.S. Department of Defense – has the best chance of being included in sustainable U.S. equity indices. For OpenAI and SpaceX, this is less likely at this point, though not out of the question.