Index Investors: Here's Why the Next Wave of Tech IPOs Could Reshape Your Passive Strategy

One of the most important discussions happening since the Space Exploration Technologies (NASDAQ: SPCX) initial public offering (IPO), and the one that's perhaps the most relevant to the investing community, is how the IPO impacts index investors.

While the SpaceX IPO was the largest in history and highly oversubscribed, there are plenty of investors out there (like me) who wouldn't touch it with a 10-foot pole. That gets complicated, however, because many value investors use passive index investing, whether as the main part or just one element, of their investment strategy.

Since SpaceX has landed on the market as one of the most valuable companies in the world, it's going to be added to many indexes and incorporated into funds that track them. In fact, it's already happening; it was added to the Russell 1000 index at the end of June, just two weeks after going public, and funds that track it will have to buy SpaceX stock to reflect that change. As of this writing, two Vanguard exchange-traded funds (ETFs) that track the Russell 1000, the Vanguard Russell 1000 ETF (NASDAQ: VONE) and the Vanguard Russell 1000 Growth ETF (NASDAQ: VONG), do not list it as a component.

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It's also being fast-tracked into the Nasdaq-100, which means the Invesco QQQ Trust ETF (NASDAQ: QQQ), one of the world's largest ETFs, will have to include it as well.

With two more high-profile IPOs on the way later this year, they may be changing the landscape for index investors.

Do IPOs change this low-risk investing strategy?

Vanguard rates most of its index-tracking ETFs with a four-out-of-five risk rating, which seems high. Its lower risk ratings, though, go to bond ETFs. The higher-risk stock ETFs get a five. That means it sees inherent risk in nearly all of its stock ETFs, and that risk is a feature, not a bug. This may be why.

Passive index investors tend to view the strategy as a low-risk path toward wealth creation. The S&P 500 has gained an annualized average of 11.4% over the past 20 years, and investing in it through a low-cost index ETF, rather than trying to beat it, reduces the risk of owning individual stocks while providing opportunities to grow your money.

SpaceX is already live, but under current rules, it won't be eligible for inclusion in the S&P 500 for at least another year. However, Anthropic and OpenAI are planning big IPOs later this year and are likely to become among the most valuable companies right away.

Investors have some time to consider their strategy. Weighted ETFs like the Vanguard S&P 500 ETF (NYSEMKT: VOO) are by nature growth-oriented, and these heavy IPOs could increase their risk. Investors who rely on them for low-risk qualities may want to diversify some of their holdings into true low-risk vehicles, such as bond or value ETFs. For example, the Russell 1000 value index does include SpaceX, but since it was classified as 90% growth and 10% value, it will only account for a small amount of the Vanguard's Russell 1000 value ETF (NASDAQ: VONV) weight when it gets included.

Jennifer Saibil has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.