Mega IPOs Like SpaceX Reshape Major Index Funds and ETFs

In June, the initial public offering (IPO) of Space Exploration Technologies (NASDAQ: SPCX) turned what seemed like a simple IPO into a reminder of how rule changes can reshape your portfolio. If you own an index fund, your portfolio may have been affected by new rules surrounding the IPO, even if you don't own SpaceX.

It all depends on which index funds you hold.

Image source: Getty Images.

What happened

Whenever a company is added to a major index, every fund that tracks that index must buy it to stay in line with the benchmark, regardless of price. And that's precisely what happened as the Nasdaq-100 and Russell 1000 each changed their rules to fast-track the inclusion of SpaceX and other major IPOs that are expected this year.

S&P Dow Jones Indices, which maintains the S&P 500, chose not to change its rules, but index funds that follow the Nasdaq-100 and Russell 1000 had to make room for SpaceX by selling a sliver of every existing security or asset. As fund managers worked to remain aligned with their indexes, giants like Apple, Microsoft, and Nvidia were trimmed. The results have been subtle but represent a very real shift in the risk and sector weights for millions of investors' portfolios.

The way both Nasdaq and Russell changed their rules to allow the mega IPO to enter sooner than usual -- rather than wait months or years for inclusion -- is what makes this moment stand out. The move concentrates a bundle of forced buying into a short window, quickly turning passive strategies into an active bet on a single, high-profile listing.

The potential implications

SpaceX's share price to date has been volatile, but that doesn't mean losses are inevitable. The fact that some of the world's largest financial firms and venture capitalists are betting on it may enhance the company's resilience to economic downturns and market fluctuations, making it a stable investment with plenty of room to grow. In other words, those who own an index fund or ETF that includes SpaceX could see their portfolios grow enough to more than offset the trimming of other market giants.

S&P's decision not to change its rules could lead to missed gains if SpaceX appreciates dramatically. On the other hand, it might just protect them from loss. Only time will tell.

In the meantime, SpaceX's debut serves as a reminder that high-profile IPOs don't just affect the new stock. They also alter every portfolio holding an index that welcomes them.

Dana George has positions in Apple. The Motley Fool has positions in and recommends Apple, Microsoft, and Nvidia. The Motley Fool has a disclosure policy.