Nasdaq’s Shame: Rigging the Index for a Billionaire
When buying and selling are controlled by legislation, the first things to be bought and sold are legislators. This quote by P.J. O’Rourke has never been more relevant, especially in the context of index investing.
Historically, indexing was a brilliant, low-cost way for investors to free-ride on the price discovery done by active managers. However, today, the tail is violently wagging the dog, and the dog has the shits. Trillions of dollars are blindly sloshing around in passive funds, and index inclusion dictates market structure rather than reflecting it.
Index Manipulation: A Masterclass
Nasdaq recently circulated a Nasdaq-100 Index “Consultation” seeking feedback from investors on proposed updates to their index methodology. However, this “consultation” is Nasdaq-speak for letting us know what they are going to force feed us.
The proposed rules are an absolute masterclass in structural market manipulation. The “Fast Entry” Exemption and the 5x Multiplier for Low-Float Stocks are two examples of how Nasdaq is bending the knee to a specific demand by SpaceX for near-immediate index inclusion.
The Fast Entry Exemption
Currently, large companies newly listed via IPO aren’t added to the index in a timely manner. Nasdaq wants to “fix” this supposed problem with a “Fast Entry” rule. Under this rule, any newly listed company whose entire market capitalization ranks within the top 40 current constituents gets announced with at least five days’ notice and added to the index after just fifteen trading days.
The 5x Multiplier for Low-Float Stocks
Nasdaq proposes a new approach for including and weighting “low-float” securities, defined as those below 20% free float. The company’s index weight would be calculated at five times its free float percentage, capped at 100%.
For example, if SpaceX IPOs at a $1.75 trillion valuation and floats 5% of the shares to the public, the company’s index weight would be calculated at 25% of its total market cap. Passive Nasdaq-100 ETFs and mutual funds are mathematically forced to buy allocations of this stock as if it were a $438 billion company.
The Lock-Up Illusion
Some may argue that the lock-up period is 180 days, and the initial index squeeze happens on Day 15. However, by waiving the seasoning period and jamming this low-float behemoth into the index immediately, you have completely corrupted the baseline.
The stock will be based on a highly distorted market structure, driven in part by continued passive inflows. And when the lock-up expires, the physical float jumps from 5% to 100%. At the very next rebalance, Nasdaq updates the math, and the passive funds are mechanically forced to increase their allocation from that artificial weighting up to the full 100%.
They are legally mandated to aggressively buy billions of dollars more of the stock the exact moment the insiders are able to flood the market with their unlocked shares.
Conclusion
In conclusion, Nasdaq’s proposed rules are a recipe for a massive, artificial supply-and-demand squeeze. The index is applying a phantom, mega-dollar weighting to a restricted, tightly-held float. Tens of billions of dollars of price-insensitive, passive capital are legally mandated to aggressively bid for the stock over a matter of days.
Therefore, it is essential to be aware of these changes and their potential impact on the market. Meanwhile, investors should conduct their own research and due diligence before making any investment decisions. Finally, it is crucial to remember that the integrity of the market is at stake, and we must ensure that the rules are fair and transparent for all participants.
