SpaceX and OpenAI: The Mega IPO Grift

Upcoming mega IPOs from private companies like SpaceX, OpenAI, and Anthropic are poised to impact public stock markets and index fund investors. If these companies go public, their sheer size means they would rank among the largest firms, forcing index funds to buy their stock, whether investors like it or not. This raises questions because IPOs have historically been poor investments, and these particular ones present unique challenges. Index funds are generally excellent investments, aiming to deliver broad public stock market returns. To fulfill this role, many stock indices include new IPOs soon after a company lists. However, this practice is problematic for index fund investors because IPOs have a history of terrible returns. With trillions of dollars under their control, index funds' mandatory buying of newly listed stocks can significantly influence share prices. This creates a desirable scenario for the IPOing company and its early investors, providing liquidity and pushing up prices, but often leaves index fund investors "holding the bag" as prices tend to revert. Companies typically go public when they believe they can sell their stock at a high price, meaning the moment public investors can buy shares is often when insiders perceive the stock as overvalued or at least fully valued. While individual investors can choose to avoid overpriced stocks, index funds lack this discretion and are compelled to buy whatever is included in their tracking index, regardless of price. IPO inclusion rules vary across indices. The S&P 500, for instance, historically required a stock to trade publicly for 12 months before inclusion, while the S&P Total Market Index allows "fast-track entry" within five days for eligible stocks. There are reports that S&P and NASDAQ are considering changes to accelerate the inclusion of mega IPOs like SpaceX into indices such as the S&P 500 and NASDAQ 100. A 2025 paper examining fast-track entry into CRSP indices (tracked by ETFs like VTI) found that expected index investor demand causes fast-track IPOs to outperform their non-fast-track counterparts by over 5 percentage points following listing. This outperformance peaks at the index inclusion date and then significantly reverts within two weeks. This suggests that intermediaries, such as hedge funds, "front-run" index funds, knowing they will be forced to buy, and then index funds are left holding shares as prices decline. The authors refer to this as a "shadow tax" largely paid by index fund investors. Another crucial concept for mega IPOs is "free float," which is the proportion of a company's shares available for public purchase. Most major indices have minimum float requirements and weight stocks by their public float. Companies can go public with a low float, making only a small portion of their market capitalization publicly available. SpaceX, for example, reportedly plans to float less than 5% of its equity, significantly lower than the average IPO. While most indices would weight it based on its float (e.g., $88 billion for a $1.75 trillion valuation with 5% float) or exclude it entirely, NASDAQ recently approved rule changes to speed up IPO inclusion, eliminate low-float cutoffs, and introduce a float factor in weighting low-float stocks. Some view this cynically, suggesting NASDAQ is changing rules to attract SpaceX's listing, which would benefit SpaceX, its early investors, and NASDAQ, potentially at the expense of NASDAQ 100 index fund investors. Despite some uncertainty regarding initial index inclusion and weighting due to varying criteria, there's no doubt that these mega IPOs will alter the public market landscape over time. Index providers are considering changes to ensure these companies are represented in their indices, as indices are designed to reflect the broader market. For instance, SpaceX, OpenAI, and Anthropic combined could represent 2.9% of the S&P World Index at their full market caps. MSCI, another index provider, calculated potential changes to the MSCI All Country World Investable Market Index if some of the largest private companies went public. Their analysis, based on different free float scenarios, indicated that even at a 25% float, the dollar flows for funds tracking MSCI indices would be substantial, with newly listed companies receiving billions in investor dollars and existing public companies seeing billions in outflows. These forced flows are critical for index fund investors. Empirical evidence consistently shows that investing in IPOs is one of the worst investment strategies. While IPOs often experience a "first-day pop," most investors don't get the IPO price. Buying shares after they are listed on the public market has generally yielded poor returns, a phenomenon known as the "new issues puzzle." A 1995 paper found that IPO investors from 1970-1990 received average returns of only 5% per year, compared to 12% for similar listed firms. A 2019 study by Dimensional Fund Advisors showed that a portfolio of IPOs from 1991-2018 generally underperformed the market and a small-cap index by about 2% per year, primarily behaving like a portfolio of small-growth, low-profitability, high-investment stocks, which are more volatile and tend to lag the broader market. The Renaissance IPO ETF, which invests in large US IPOs and sells after three years, has underperformed VTI (tracking the total US market) by over six percentage points annualized since its inception in 2013, exhibiting characteristics of small stocks with high prices, low profitability, and aggressive asset growth. Professor Jay Ritter's data from 1980-2023 indicates that the average three-year buy-and-hold return for IPOs purchased on the secondary market trails the market by 19 percentage points. Low-float IPOs, particularly those expected from companies like OpenAI and SpaceX, appear especially problematic. Professor Ritter's research on 11 low-float (below 5% float) IPOs for companies with over $100 million in inflation-adjusted sales since 1980 found that 10 of them underperformed the market within three years, with average underperformance of roughly 50% from the offer price and over 60% from the first-day close. This suggests that constrained supply can drive early price spikes but is often followed by significant underperformance. These examples also tended to have high price-to-sales ratios at IPO. If SpaceX achieves a $1.75 trillion valuation, its price-to-sales ratio would exceed 100 times, significantly higher than the S&P 500 average of 3.1 times, and high valuations are generally associated with low expected future returns. For index fund investors, this issue is complex. When large private companies go public with high valuations, indices must rebalance to reflect the broader market, and market-cap-weighted index funds implicitly engage in market timing. However, this timing tends to be poor, as issuers list stock when they believe valuations are high, leading index funds to buy high and sell low. A 2025 paper estimates this timing creates a performance drag of 47-70 basis points per year compared to a delayed rebalancing approach. This lasting negative effect could be avoided if index funds prioritized expected returns over tracking error. Some investment strategies, like those used by Dimensional Fund Advisors, are similar to index funds but intentionally avoid investing in IPOs for about a year after listing and tilt away from the "junk" characteristics often found in IPOs. Regarding investing in private company shares before they go public, there's significant survivorship bias. For every successful company like SpaceX, thousands fail. Fees and costs associated with private investments can also absorb potential financial benefits, as seen with private equity funds delivering net-of-fee returns similar to public markets. Attempts to gain early exposure to companies like SpaceX through special purpose vehicles (SPVs) have involved high fees and complex structures, sometimes leading to losses for investors. While some ETFs have bought into private companies via SPVs, even with reported value increases, these funds can underperform due to illiquidity and complex structures. It is generally difficult to access desirable private company shares on favorable terms, as financial intermediaries are not typically in the business of giving away money. However, public companies do make strategic investments in private companies, offering some indirect exposure to private markets for public market investors. In summary, index fund investors may soon be affected by mega IPOs, potentially being forced to buy shares of companies with high valuations and a history of poor post-IPO performance. This is an inherent cost of the indexing approach. Investors can either accept this or consider alternatives that avoid automatic IPO investment. Accessing private company shares before IPOs is challenging, often costly, and carries significant risks due to survivorship bias and complex fee structures.