Original Title: Everything You've Been Told About Index Funds Is No Longer True: Phil Bak
Original Author: Quoth the Raven
Original Translation: Peggy
Let's talk about what is happening in the capital markets, especially regarding index funds. But before we do that, we need to understand what it looks like when one "falls from grace." For that, we need to discuss Pete Rose.
Pete Rose is not just a baseball star; he is almost the embodiment of what "baseball star" means to all baseball fans. He is covered in mud, gives his all, is tough, and resilient. Later, he became a player and coach, representing a team and becoming a symbol of the sport.
But in this process, he made some mistakes. It turned out that he made the most serious mistake of that era: betting on the sport he was a part of. In hindsight, this is ironic because sports betting is now available on everyone’s phones and is constantly advertised during various sporting events. But back then, people still cared about some old-fashioned concepts like "integrity." So the league decided to make an example out of Pete Rose.
Fifteen years later, a broken Pete Rose had to lend out his remaining fame to WrestleMania to pay his bills. Soon, he found himself standing in the ring facing a 400-pound Samoan wrestler, Rikishi.
I must caution you: watch with care. Rikishi has a signature move called the stinkface. The move is as "tasteful" as its name suggests: Rikishi would trap his opponent in the corner of the ring and then turn around and back up, shoving his massive backside into the opponent's face, while the audience goes wild.
You can look it up yourself. It is as bad as it sounds.
As Rikishi rubbed his gigantic backside against Pete Rose's face, if you looked closely, you would see something quite rare: a certain expression in Pete's eyes. It was a mix of sadness and acceptance. It was the expression of a person realizing how far they had fallen. His gaze was no longer angry or combative toward his circumstances; it had become dazed, weary, and accepting of this new, sorrowful reality.
John Bogle is no longer with us. I can only imagine the expression he would have if he saw what is happening to index funds today. I can only imagine it would be a similarly sorrowful look. A dazed, weary acceptance: that his great invention, which once stood so high, is now sinking into the depths of fraud.
If you’ve been reading my articles for a long time, especially when I used to write more about stocks and ETFs, you might guess what I'm going to say. But if you are a new reader, let me provide some background. Here is how things actually unfolded:
Low-cost investing was once a powerful narrative that placed the ordinary investor on the opposite side of greedy Wall Street;
This narrative drove capital into passive index funds;
The inflow of funds drove performance, causing the market capitalization-weighted factor—essentially a combination of anti-scale and momentum factors—to outperform all other factors;
Outperformance led to more inflows, thus closing the loop;
The volume of options surpassed the volume of stock spot transactions, with derivatives linked to major indices beginning to drive prices more deeply than the index funds themselves;
And just like that, valuations ceased to matter to the market.
All of this has brought us to today and to the Rikishi moment we are facing. This moment is the SpaceX IPO.
First, Nasdaq changed the rules for the Nasdaq-100 index, making it easier and faster for newly listed large-cap companies like SpaceX to enter the index. These rule changes seemed to undermine traditional index standards regarding float, liquidity, investability, and replicability. Time will tell whether this is good or bad for investors. But one thing is certain: it is very favorable for Nasdaq in securing SpaceX’s choice of it as a primary listing venue.
You can certainly say that allocating stocks based on primary listing exchanges is crazy. You would be correct in saying so. I have attended those presentations, and why a company chooses to list on the NYSE or Nasdaq has absolutely nothing to do with the relative investment value of S&P or QQQ. We are talking about two completely disconnected worlds.
For example, people think they are buying Nasdaq-100 stocks when they are actually buying Costco, Walmart, and a bunch of other stuff. They might think they can buy Oracle or Uber, but they cannot because those companies chose to list on the NYSE, and the reason has nothing to do with your portfolio. So you miss out on them.
It’s insane.
But it has always been like this. And now it is worse. Because this time, it is not just about the listing location. All index providers have changed their index methodologies just to force companies like SpaceX, Anthropic, and OpenAI into the index. If valuations still matter, at what valuation levels will index fund investors buy these companies will make you want to vomit.
According to Hedgeye, the damages are as follows:
Rule changes surrounding the SpaceX IPO:
Index providers waived profitability requirements and shortened the post-listing observation window from 90 days to 5 days.
This will force over $30 trillion in passive 401(k) and retirement funds to buy SpaceX at IPO valuations.
Bloomberg Intelligence estimates that S&P 500 funds must absorb 19% of SpaceX’s float within 6 months.
Russell 1000 and Nasdaq-100 funds will absorb 24%.
The rules that were originally meant to protect passive investors:
The S&P 500 has required companies to have a 12-month trading history and to deliver GAAP profits for four consecutive quarters since 2002. Now, both requirements have been waived.
Nasdaq shortened its window from 90 trading days to 15 trading days.
FTSE Russell shortened it to 5 trading days.
These three benchmark indices are now designed to buy SpaceX at IPO pricing levels.
This is the moment. The "jumping the shark" moment for index funds. This is the moment when the great Pete Rose stares at Rikishi’s gigantic backside with a look of despair.
Investors are no longer simply outsourcing individual stock selections. They are also outsourcing asset allocation, IPO discipline, liquidity judgment, valuation discipline, choice of listing venue, and due diligence principles altogether. They have handed over all control in their trading to the index committees, which can sway with the wind.
Indices are no longer neutral. They are making active bets on the most inflated companies and are betting at the highest valuation points.
Active management has never had a better entry point. Direct indexing has never been more important. A significant shift is finally near.
Everything you have heard in the past about "smart but boring" index funds is no longer valid.
While you still can, get out quickly. Choose your own methodology, choose your own factors, choose your own stocks, and take back control of your investment portfolio.
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