Citadel’s head of securities trading sees Tesla creating risks in S&P

(Bloomberg) – Historical entry of Tesla Inc. in the S&P 500 could be bad news for shareholders of other shares in the index – at least temporarily.

Funds that mimic the benchmark will buy more than $ 70 billion in the carmaker’s shares and throw an equal amount of shares into existing members, producing intense selling pressure that could lead to dislocations, warned Greg Sutton, head of portfolio trading at Citadel Securities, one of the most active stock traders in the US.

The potential funding stress is a factor that led index supervisors to consider implementing the two-installment addition. After consulting with the financial community, the S&P Dow Jones Indices decided that Tesla will join the traditional way: in one fell swoop, before the markets open on Monday. The danger is that trading in many stocks may not be active enough to absorb the sudden flood of supply.

“Simultaneous addition creates more shares that need to be sold for financed trading, which potentially creates a greater impact – especially in the less liquid components of the S&P 500,” Sutton said by telephone. “The market can digest it, but there is the potential for an impact on liquidity.”

While S&P 500 members are frequently shuffled, Tesla’s enormous size adds an unusual layer of uncertainty this time around. With a market capitalization of over $ 600 billion, Elon Musk joins as the sixth largest company in the index. Because the stock it replaces – Apartment Investment and Management Co. – it is only a small part of the size of Tesla, all the other constituents risk to feel the pinch.

For Howard Silverblatt, a senior analyst at S&P Dow Jones, trading with Tesla is the easiest thing for professionals to do, because it’s just a matter of how much they’re willing to pay. A bigger challenge, as he sees it, involves hundreds of stocks that are selling practically at the same time.

“There are things they’ve all done before, but not on this scale,” Silverblatt said. “There should be a lot of fuss, but hopefully it will go well.”

Berkshire Hathaway Inc., Procter & Gamble Co. and Johnson & Johnson are among the stocks facing risks due to high selling pressure, according to data compiled by Kevin Muir on the MacroTourist blog. It is estimated that the trio each has a number of shares to be sold, which is equal to the average daily trading volume in the last three months. Although it may not seem like much, imagine if sales increase in the last minutes of Friday’s session, the last trading window before Tesla enters. This is when passive investors tend to intensify transactions so as to follow the benchmark as closely as possible.

To be sure, gigantic additions like this have happened before. Tesla is the largest market value participant in history. However, when measured as a percentage of the S&P 500, its weighting is similar to that of the Berkshire Hathaway in 2010, when Warren Buffett was chosen to join, according to data compiled by Sanford C. Bernstein. However, with passive investments now accounting for about half of equity, up from 30% a decade ago, the demand for funding this time around will be much higher, analysts including Toni Sacconaghi and Ann Larson have warned. .

Tesla shares rose more than 2% at the start of trading on Friday. Since S&P Dow Jones announced the news of the addition of Tesla on November 16, the stock has grown by more than 60%. During this period, about 52 million shares changed hands every day, on average 77% more than the previous month. In the last decade, the top 10 new entrants have risen by an average of 10% from the announcement to their actual inclusion, Bernstein’s analysis showed.

Money managers may have already started adjusting their portfolios in anticipation of the changes, with Tesla shares offering earlier this month providing an opportunity to build positions. Some may opt for part of the transaction in the days leading up to the event, leaving a residual amount to be settled around Friday’s close. To minimize tracking errors or deviation from the benchmark, some may choose to use market closing commands or use options to aid performance.

“They will take all the stops,” said Ben Johnson, director of global ETF research at Morningstar Inc. “They will not take a single approach, they will not use any tactics in isolation, but they will use all the tools at their disposal to try again not to leave a mark and minimize costs for their investors. “

Tesla Going in the S&P 500 is what Smart-Beta geeks have warned

Friday is set to be one of the busiest trading sessions on record, with other scheduled market events typically stimulating a flow of equity transactions – index rebalancing, as well as expirations of options and futures on indices and equities .

US stocks hit an all-time high of more than 19 billion shares a day in late February amid the bear market massacre. Although some stocks may suffer dislocations due to the sale of Tesla, Sutton at Citadel Securities is confident that the wider market structure is well equipped to deal with the turmoil.

What happened earlier this year “was actually a decent stress test for the system, and overall everything seemed to be going well,” Sutton said.

(Updates to Tesla’s pre-market price.)

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