Episode 406: When Massive Private Companies Go Public

Episode Summary

Executive Summary: The episode examines how mega-IPOs from large private firms like SpaceX and OpenAI could affect index construction, fund flows, and returns. The hosts argue index funds may be forced to buy high-priced IPOs to stay representative, but the actual impact depends heavily on float rules and index methodology. They conclude this is a real but not fatal inefficiency, and investors should stay disciplined.

Main Topics: PWL acquisition and advisor growth (Priority: 3/5): The hosts open with PWL Capital’s acquisition of McDonald Shimko & Company in Vancouver, describing it as an expansion of PWL’s integrated, planning-driven wealth management platform and a sign of continued national growth. Why mega-IPOs matter for index investors (Priority: 5/5): The main topic is the potential public listing of very large private companies and whether index funds will be forced to buy them at inflated prices, potentially hurting index fund investors while benefiting issuers and early holders. How index inclusion rules differ (Priority: 5/5): They compare S&P, Nasdaq, CRSP, and MSCI methodologies, emphasizing that float thresholds, seasoning periods, and weighting rules determine whether and how much these companies enter an index. IPO underperformance and front-running (Priority: 5/5): They review academic evidence showing IPOs often underperform and explain that index inclusion can create demand that gets front-run by intermediaries, leaving index investors with poorer post-inclusion returns. Free float and concentration risk (Priority: 4/5): The discussion highlights that low public floats can dramatically reduce a company's effective index weight, and that many of the feared mega-IPO impacts may be smaller than headlines suggest if only a tiny fraction of shares trades publicly. Alternative fund approaches: Dimensional and Avantis (Priority: 4/5): The hosts contrast traditional index investing with factor-oriented fund families. Dimensional delays IPO inclusion; Avantis may include newly listed firms if fundamentals and expected returns justify it, showing different trade-offs. Private market FOMO and access issues (Priority: 4/5): The episode closes by arguing that investors often overestimate the value of private market access. SPVs, ETFs, and private deals often carry high fees, complexity, and fraud risk, while public companies already provide indirect exposure to private winners.

Key Arguments: Index funds should broadly track the market, so excluding IPOs outright can distort representation even if IPO returns have historically been poor. The real effect of mega-IPOs depends on float: a $1.75T company with only 5% float is economically much smaller to index funds than headlines imply. Fast-track inclusion can raise prices before index funds buy, effectively creating a 'shadow tax' on index investors via front-running. Historical research shows IPOs generally underperform, especially low-float, high-valuation IPOs. Low float and high price-to-sales are especially bad signs; expected returns fall as valuations rise. Index providers may revise rules for noble reasons (market representation) or strategic reasons (exchange competition), but either way the rules matter for fund outcomes. Traditional market-cap indexing still works well overall, and these structural inefficiencies are costs, not fatal flaws. Dimensional and Avantis manage IPO exposure differently, but each approach introduces its own trade-offs and tracking differences. Trying to access private-company upside directly often leads to high fees, illiquidity, or fraud risk, while broad market ownership already provides indirect exposure to many private winners.

Data Points: Episode number: 406 - Podcast episode identifier mentioned at the start. PWL acquisition: McDonald Shimko & Company joined PWL in Vancouver - Opening announcement about firm growth and a new office presence in Vancouver. Vanguard fund size: $2 trillion - Referenced as a single Vanguard fund with assets across mutual fund and ETF share classes. S&P 500 public-listing seasoning period: 12 months - Current rule requiring a stock to trade publicly for a year before S&P 500 inclusion. S&P Total Market fast-track entry: within 5 days - S&P total market index can include certain eligible IPOs quickly through fast-track entry. Nasdaq 100 low-float minimum: reduced to 1% float - Nasdaq’s revised methodology allows inclusion of companies with very small public floats. Nasdaq old float approach: no regard for free float in weighting - Previously Nasdaq 100 weights were based on full market capitalization of eligible listed shares. CRSP low-float cutoff: 10% float - VTI’s tracked CRSP total market index excludes fast-track entry for stocks below this threshold. Fast-track IPO outperformance: over 5 percentage points - Marco Sammon paper found fast-track IPOs outperformed non-fast-track IPOs by more than five percentage points after listing. Post-inclusion reversion: within 2 weeks - The fast-track outperformance peaks at index inclusion and then reverses shortly afterward. Estimated annual drag from composition changes: 47 to 70 basis points per year - Sammon’s paper estimates performance drag from market-cap-index rebalancing versus delayed rebalancing. Free-float valuation example for SpaceX: $88 billion - A $1.75T company with 5% float would have an $88B free-float value used by float-weighted indexes. MSCI private-company scenario: 4 of 10 companies eligible at 5% float - MSCI’s scenario analysis of large private companies going public in 2026. MSCI private-company scenario: 7 of 10 companies eligible at 10% float - MSCI scenario analysis at a 10% float assumption. SpaceX/OpenAI/Anthropic share of MSCI World: 2.9% - S&P blog post said these three firms would equal 2.9% of the S&P World index at full market cap. Ritter sample of low-float high-sales IPOs: 11 IPOs - Jay Ritter identified 11 IPOs with below-5% float and at least $100M inflation-adjusted trailing sales. Underperforming low-float IPOs: 10 of 11 - Nearly all of Ritter’s low-float, high-sales IPO sample underperformed the market within three years. Low-float IPO underperformance: ~50% from offer price; ~60% from first-day close - Ritter’s table showed severe underperformance for the sample over three years. IPO portfolio long-run underperformance: ~2% per year - Dimensional’s study of 6,000+ IPOs from 1991-2018 found IPO portfolios lagged the market and small-cap index by about 2% annually. Renaissance IPO ETF underperformance: more than 6 percentage points annualized - Since October 2013, the ETF that buys IPOs underperformed VTI by over six percentage points annually. Price-to-sales example for SpaceX: more than 100x - At a $1.75T valuation, SpaceX would trade above 100 times trailing sales. S&P 500 current aggregate price-to-sales: 3.1x - Used as a contrast to SpaceX’s hypothetical IPO valuation. Highest S&P 500 price-to-sales example: 73x - Palantir cited as the highest current S&P 500 constituent price-to-sales ratio mentioned. Private SPV fee structure: 4% upfront + 25% of future profits - A reported SpaceX SPV structure cited as an example of costly access to private shares.

Pivotal Quotes: "If you're going to buy the haystack, you need to buy all of the hay." — Listener/community reference quoted by Ben Felix: Used to defend why index funds should generally include IPOs if they are meant to represent the whole market. "This is a cost that you have been paying and still outperformed most everything." — Ben Felix: Summary point that IPO inclusion inefficiency exists, but index funds remain highly effective overall. "When it comes to investing, the more you covet something, the more you should probably question your desire to own it in the first place." — Jeff Tack (cited by Ben Felix): Applied to investor FOMO over private-company exposure and private-market products.

Implications: Mega-IPOs could temporarily distort index flows and returns, but the effect depends on float and methodology. Investors should understand their fund’s rules, avoid FOMO-driven private-market products, and stay committed to a disciplined long-term strategy.