IPO Inclusion Risks: Shadow Tax on Index Fund Investors

Name: SpaceX and OpenAI: The Mega IPO Grift
Uploaded: 2026-04-05T10:26:46.671136+00:00
Duration: 18 min 44 s
Channel: Ben Felix
Description: Summary and key takeaways on SpaceX and OpenAI: The Mega IPO Grift: Summary & Key Takeaways, covering The Mechanics of IPO Inclusion Index funds must buy newly

Ben Felix

Apr 05, 2026

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18 min video

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2 min read

YouTube video ID: iOyFja87uyw

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Index funds must buy newly listed stocks that meet index criteria, even if valuations are high. Fast‑track rules let some indices add a stock within as few as five days, and the S&P 500 and NASDAQ are weighing rule changes to accelerate inclusion of mega‑cap IPOs such as SpaceX. Inclusion supplies liquidity to sellers and pushes the share price up, but the benefit accrues to the sellers while index fund holders absorb the cost.

The “Shadow Tax” on Investors

Hedge funds and other intermediaries front‑run index funds by buying shares before inclusion and selling them as the funds purchase, capturing the price premium. Research shows fast‑track IPOs outperform non‑fast‑track peers by more than 5 % before inclusion, then revert sharply. Rebalancing to add new IPOs drags performance by an estimated 47–70 basis points per year.

The “New Issues Puzzle”

IPOs consistently lag the broader market. A 2019 study found a 2 % annual underperformance versus small‑cap indices, and a 1980‑2023 analysis showed a 19‑percentage‑point gap in three‑year buy‑and‑hold returns. IPOs often resemble “junk” stocks: they are small, growth‑oriented, low‑profitability, and heavily invested in. Low‑float IPOs (under 5 % public equity) amplify volatility and typically lose about 50 % of their offer price within three years. High price‑to‑sales ratios at IPO predict lower future returns.

Private Market Exposure

Retail investors seeking private‑company exposure face high fees, opaque structures, and survivorship bias. Special Purpose Vehicles charge large upfront fees and profit‑sharing, while liquid ETFs that hold illiquid private assets struggle with redemption pressures and have underperformed the broader market. Dimensional Fund Advisors avoids IPOs for roughly a year after listing, and the Renaissance IPO ETF has lagged VTI by more than 6 % annualized since 2013.

Strategic Alternatives

Investors can question the desire to own newly listed mega‑caps, recognizing that financial intermediaries rarely give money away for free. Alternatives include waiting for a post‑IPO cooling‑off period, using funds that deliberately exclude recent IPOs, or allocating to diversified private‑equity vehicles with transparent fee structures.

Takeaways

Index funds must purchase newly listed stocks that meet index criteria, even when valuations are inflated, creating forced buying pressure.
Fast‑track IPOs generate a temporary price boost that front‑running hedge funds capture, leaving index investors with a subsequent price decline.
Rebalancing to include IPOs adds a systematic performance drag of roughly 47–70 basis points per year for index fund portfolios.
Historical data shows IPOs underperform the market by 2 % annually on average, with low‑float offerings suffering especially large losses.
Retail exposure to private companies via SPVs or illiquid ETFs incurs high fees and often delivers poorer returns than public market alternatives.

Frequently Asked Questions

Why do fast‑track IPOs create a performance drag for index funds?

Fast‑track IPOs attract early buying by hedge funds that sell to index funds at inclusion, inflating the price temporarily. When index funds must rebalance and hold the overvalued shares, the price reverts, producing a drag of 47–70 basis points annually.

What is the 'shadow tax' that index fund investors pay when a mega‑cap IPO joins an index?

The shadow tax refers to the hidden cost incurred by index investors when intermediaries front‑run the inclusion of a new IPO, capturing the premium and leaving the index fund with a subsequent price decline that reduces overall fund performance.

Who is Ben Felix on YouTube?

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are weighing rule changes to accelerate inclusion of mega‑cap IPOs such as SpaceX. Inclusion supplies liquidity to sellers and pushes the share price up, but the benefit accrues to the sellers while index fund holders absorb the cost. ## The “Shadow Tax” on Investors Hedge funds and other intermediaries front‑run index funds by buying shares before inclusion and selling them as the funds purchase, capturing the price premium. Research shows fast‑track IPOs outperform non‑fast‑track peers by more than 5 % before inclusion, then revert sharply. Rebalancing to add new IPOs drags performance by an estimated 47–70 basis points per year. ## The “New Issues Puzzle” IPOs consistently lag the broader market.

2019 study found a 2 % annual underperformance versus small‑cap indices, and a 1980‑2023 analysis showed a 19‑percentage‑point gap in three‑year buy‑and‑hold returns. IPOs often resemble “junk” stocks: they are small, growth‑oriented, low‑profitability, and heavily invested in. Low‑float IPOs (under 5 % public equity) amplify volatility and typically lose about 50 % of their offer price within three years. High price‑to‑sales ratios at IPO predict lower future returns.

Helpful resources related to this video

If you want to practice or explore the concepts discussed in the video, these commonly used tools may help.

The Intelligent Investor Benjamin Graham Book Recommended

This classic text provides foundational knowledge on value investing and market psychology, helping investors understand why chasing hyped IPOs often leads to poor long-term results.

Amazon →

Random Walk Down Wall Street Book

This book explains the mechanics of market efficiency and the risks of active trading, reinforcing the author's critique of IPO-heavy strategies and index fund rebalancing drag.

Amazon →

Common Stocks And Uncommon Profits Book

Provides a framework for evaluating company quality and growth, which helps investors distinguish between sustainable businesses and the 'junk' IPOs described in the brief.

Amazon →

Links may be affiliate links. We only include resources that are genuinely relevant to the topic.

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Full Transcript YouTube

Some massive companies are set to go
public very soon. Private companies like
SpaceX, OpenAI and Anthropic would rank
among the largest companies if they went
public and index funds would be forced
to buy their stock. That means that if
you are an index fund investor, you may
soon be investing in these companies
whether you like it or not. The problem
is that most IPOs are terrible
investments and these ones in particular
raise some questions. I'm Ben Felix,
chief investment officer at PWL Capital,
and I'm going to tell you what the
upcoming mega IPOs mean for you and your
portfolio.
In this video, I'm going to take you
through how stock indices and the index
funds tracking them include IPOs, how
this might affect index fund returns,
and what you can do about it. I'll also
cover whether index fund investors are
missing out on private market returns,
which is a common perception based on
companies staying private longer. Index
funds are generally great investments
because they roughly deliver the returns
that the public stock market has to
offer. Since their primary role is
representing the stock market, some
stock indices aim to include new IPOs
soon after the company goes public. This
makes sense for the purpose of
representing the public stock market.
But the problem for index fund investors
is that IPOs have had historically
terrible returns. I'll come back to that
point later. Index funds today control
trillions of dollars. So, if you're a
new company listing on the stock market
or an investment bank facilitating an
IPO, getting the stock included in a
major index or multiple indices can mean
huge investment dollars flowing into its
shares on the public market as index
funds are forced to buy, giving sellers
liquidity and pushing up the share
price. This makes index inclusion very
desirable for shareholders of the newly
listed company, but probably not so much
for the index fund investors who are
left holding the bag. And it is often a
bag that they are left holding.
Companies tend to go public when they
think they can sell their stock at a
high price. Meaning, the moment you can
buy their stock on the secondary market
is precisely when the insiders believe
it's overvalued or at least nicely
valued. If you're an investor, you
probably don't want to buy an overpriced
stock, but index funds don't have that
kind of discretion. They're forced to
gobble up whatever is included in the
index, regardless of its price. The IPO
inclusion rules vary across indices. For
example, as of right now, the S&P 500
requires a stock to have been trading on
a public exchange for 12 months before
inclusion, while the S&P total market
index allows for inclusion within 5 days
for stocks that meet certain criteria.
This is called fasttrack entry which is
important to understand. Basically
stocks that meet certain criteria can be
eligible for near immediate inclusion in
some total market indices. As I
mentioned, the S&P 500 has historically
required shares to trade for a year
before inclusion. But as reported by
Bloomberg, S&P may be considering an S&P
500 rule change to accelerate the
inclusion of mega IPOs like SpaceX.
NASDAQ is considering similar changes
for the NASDAQ 100 to accelerate
inclusion. The implications here for
index fund investors are important. A
2025 paper looks at how fast track entry
into Crisp, that Center for Research and
Security Prices Indices affects stock
returns and IPO deal structure. VTI, for
example, a large ETF, tracks the CRISP
US total market index. Crisp adds
eligible securities to the index within
as few as 5 days for fasttrack entry.
The authors of this paper show that
expected index investor demand for IPO
shares causes FastTrack IPOs to
outperform their non-fastrack
counterparts by over 5 percentage points
following their listing. This
outperformance peaks at the index
inclusion date and reverts significantly
within two weeks thereafter. Basically,
index funds are being frontr run by
intermediaries like hedge funds who know
that index funds are going to be buying
the shares once they become eligible for
index inclusion and then the index funds
end up holding the shares as they revert
back down closer to their IPO price. The
authors call this a shadow tax largely
paid by index fund investors. It's like
ticket scalpers for concerts and sports
events. Another important index
definition that's proving to be relevant
to mega IPOs is the concept of free
float. Free float is the proportion of a
company's shares that are available for
purchase in the public equity market.
Most major indices have a minimum float
requirement and weight stocks by their
public float. A company could go public
while only making a small portion of
their overall market capitalization
freely available on the public exchange.
This would be referred to as a lowflat
IPO. As reported by the Financial Times,
SpaceX plans to float less than 5% of
its equity, much lower than the average
IPO. With a $ 1.75 trillion valuation,
but only a 5% public float, most indices
would weight it at its float of 88
billion, and many would actually exclude
it altogether. NASDAQ currently has a
10% minimum float and weight stocks
based on the value of all listed shares
of the company with no regard for free
free float, which is unique. But they
recently approved rule changes following
a public consultation to speed up IPO
inclusion, eliminate the lowflat cutoff,
and introduce a float factor in their
waiting of lowflat stocks. The cynical
view on this is that NASDAQ is changing
the NASDAQ 100 index rules to win SpaceX
over in an effort to get their listing
on the NASDAQ exchange. including in the
index would force significant index fund
buying, which likely ends up being good
for SpaceX, its early investors, and
NASDAQ, but potentially comes at the
expense of NASDAQ 100 index fund
investors. Some indices like the crisp
US total market index tracked by VTI
continue to have a low float cutoff of
10% for fasttrack entry into the index.
Between inclusion criteria and index
waiting methodologies, there's some
uncertainty about how these mega IPOs
will initially show up in indices. But
there's no question that their listings
will change the public market over time.
That's likely why index providers are
considering making changes to get these
companies represented in their indices.
To reiterate a point from earlier,
indices are meant to represent the stock
market. A blog post from index provider
S&P Global shows that just SpaceX,
OpenAI, and Anthropic would make up 2.9%
of the S&P World Index at their full
market caps. That's almost as much as
Canada. But these numbers assume that
the total market cap of the companies is
included in the index. Since many of
these IPOs are expected to have low
public floats, that should be accounted
for in estimating their market impact.
In another blog post, index provider
MSCI calculated the potential changes to
the MSCI allcountry world investable
market index in the event of some of the
largest private companies going public
in 2026. This was written back in
February 2026 when SpaceX had a quaint
valuation of only 800 billion, but the
general points are still relevant. They
ask in the blog post what would happen
to the index to this world index if the
10 largest companies from the Msei all
country venturebacked private company
index went public. Since the free float
at the time of listing is unknown, they
go through a few scenarios. At a 5%
float, only four of the 10 large private
companies would achieve index inclusion
based on MSCI's inclusion rules. At a
10% float, seven of the 10 companies
would achieve index inclusion, but not
at enormous weights in the index. While
the overall market weight changes in
percentage terms would not be huge, even
at a 25% float scenario, MSEI finds that
the dollar flows just for funds tracking
MSCI indices would be huge with newly
listed private companies receiving
billions in investor dollars and the
largest existing public companies seeing
billions in outflows. These flows are
what ultimately matter to index fund
investors who are being forced to buy
shares. Okay, so index funds, depending
on the rules of the specific indices
they track, may or may not invest in
these mega IPOs. And even if they do, it
will likely be at a weight reflecting
their public float, except for the
NASDAQ 100, which as of recently would
use its newly adopted float factor. An
important piece of understanding this
whole situation is the empirical fact
that investing in IPOs is one of the
worst investment strategies that exists.
Before I get to that though, make sure
to subscribe if you haven't already. I
make nerdy research-driven videos to
help you make more informed financial
decisions. Okay, IPOs tend to have a
first day pop where the price on the
public market jumps up relative to the
IPO price, but most investors don't get
the IPO price. Investing in the shares
once they are listed on the public
market, so after the pop has been rough
to say the least. The consistent pattern
of IPO underperformance even has a name.
It's the new issues puzzle coined in a
highly cited 1995 paper which found that
companies issuing stock from 1970 to
1990 tended to be poor investments. The
paper finds that investors in IPOs
receive average returns of only 5% per
year while similar listed firms returned
12% over the same period. The paper
notes that to achieve the same wealth 5
years later, an investor would have had
to put 44% more money into the new
issues in the sample than into
established firms of the same size. A
more recent 2019 study from Dimensional
Fund Advisors looked at the first year
secondary market performance of more
than 6,000 IPOs from 1991 to 2018 and
found that a portfolio of IPOs generally
underperformed the market and a small
cap index by about 2% per year. The main
exception to this finding was in the
1992 to 2000 period when the IPO
portfolio outperformed the small gap
index by about 1.1% annually mainly due
to IPOs consisting of small tech
companies that took off in the dotcom
boom and uh I mean we all know what
happened after that. The study found
that these poor returns were largely
explained by the factors in the FM and
French five factor asset pricing model.
The IPO portfolio behaves like a
portfolio of small growth,
lowprofitability, high investment
stocks, also known as junk or small crap
growth. These types of stocks are more
volatile and tend to lag behind the
broader market. We don't even need these
papers though. These findings are easy
for anyone to replicate and update today
because of course there is an ETF for
IPOs. The Renaissance IPO ETF
exclusively invests in large US IPOs
when they list and then sells the shares
after they've been public for three
years. It has underperformed VTI which
tracks the total US market by more than
six percentage points annualized since
inception in October 2013. And as
expected, it behaves like a portfolio of
small stocks with high prices, low
profitability, and aggressive asset
growth. Similar results can be found
internationally since 2014 with the
Renaissance International IPO ETF IPOS.
Yes, that is the real ticker. Professor
Jay Ritterder, co-author of the new
issues puzzle, maintains an up-to-date
database of IPO returns. In that data
spanning 1980 through 2023, the average
three-year buy and hold return for IPOs
purchased on the secondary market trails
the market by 19 percentage points.
Lowflat IPOs look particularly bad.
Remember, a lowflat IPO means that only
a small portion of the company's shares
are available for public trading, which
can amplify price swings because demand
is concentrated on a limited supply.
This is widely expected to be the
approach for companies like OpenAI and
SpaceX. Lowflat IPOs for high revenue
companies are rare, but they're not
totally unheard of. I reached out to
Professor Ritterder, a past guest on my
podcast, to see if he had any data on
large lowflat IPOs specifically. He sent
me this table, which you nerds are
getting an exclusive look at. He found
11 lowflat, that is below 5% float IPOs
for companies with inflationadjusted
trailing 12-month sales of $100 million
or more going back to 1980. 10 of the 11
IPOs underperformed the market within
three years with average
underperformance of roughly 50% from the
offer price and over 60% from the first
day close suggesting that constrained to
supply may drive early price spikes but
tends to be followed by significant
underperformance. He also mentioned that
these examples tended to have high price
to sales ratios at the time of IPO which
is very relevant for the current
potential mega IPOs. If SpaceX were to
achieve a $ 1.75 trillion valuation, it
would have a price to sales ratio of
more than 100 times based on trailing
sales. For context, the highest price to
sales ratio for an S&P 500 constituent
today is Palanteer's 73 times, while the
index as a whole trades at a price to
sales of 3.1 times. In general, high
valuations are associated with low
expected future returns. For index fund
investors, this problem is complicated.
When large private companies go public
with high valuations, they change the
landscape of the broader market. In
response, indices must rebalance to
remain reflective of the broader market.
Market cap weighted indices must
rebalance in response to stock market
composition changes, which in some cases
can include IPOs. In doing so, index
funds implicitly engage in market
timing. The problem is that it tends to
be really bad market timing. Issuers,
that's like companies listing on the
public market, will generally want to
issue stock when their valuation is
high, when when they believe their
valuation is high and buy it back when
their valuation is low. Index funds in
their effort to track the indices that
reflect the market end up buying high
and selling low. The 2025 paper index
rebalancing and stock market
composition, do indexes time the market?
estimates that this timing ends up
creating a performance drag of between
47 and 70 basis points per year relative
to a delayed rebalancing approach. In
other words, there is a lasting negative
effect on your portfolio that could have
been avoided had your index fund
prioritized expected returns rather than
tracking error to its index. Listen, I'm
a huge fan of index funds, but this
issue right here is one of the reasons
that I don't use them personally or for
the clients of PWL Capital. I use funds
from Dimensional Fund Advisors, which
are a lot like index funds, but don't
track an index, and intentionally avoid
investing in IPOs for about a year after
the company lists. They also
intentionally tilt away from the junk
that IPOs tend to behave like more
generally. To be clear, my firm PW
Capital does use Dimensional Funds, but
I was not paid by Dimensional or anyone
else to say this, and I gain nothing
from you using their products. With
companies staying private longer and
going public when they're larger, the
next question that is natural to ask is
whether investors should be seeking
exposure to private company shares
before they go public. There are a
couple of things to think about here.
There's a huge amount of survivorship
bias in private company outcomes. For
every SpaceX or Open Eye that we hear
about, there are thousands of companies
that did not grow or failed entirely.
This skewess exists in public markets
too, but it's even more brutal, even
more pronounced in private markets.
Additionally, the fees and costs
associated with private company
investments can often absorb the
financial benefits of owning them. This
has been true with private equity funds
in general, which have delivered net of
fee returns in line with public markets.
There are some wild stories floating
around right now about the lengths
people have gone to to buy what they
hope is exposure to companies like
SpaceX. One specialurpose vehicle
reported on by Wall Street Journal had a
4% upfront fee with an additional fee of
25% of future profits. There are also
questions about who owns what due to the
complicated structures. And of course,
there are stories of outright fraud. I
think people imagine all the money they
will make if they can buy some SpaceX
shares at a low valuation and then sell
when it goes public. But unless you're
an employee or otherwise have direct
access to the company's shares,
financial intermediaries that do have
access are not typically going to give
you access to the equity on terms that
are better for you than they are for the
intermediary. Financial intermediaries
don't tend to be in the business of
giving you money for free. Some ETFs
have gotten exposure to SpaceX shares
either directly or through specialurpose
vehicles. One example that has attracted
a lot of attention is the ERS shares
private public crossover ETF. It bought
into SpaceX through an SPV in December
2024. SPVS are not particularly liquid.
So, this ETF has had to deal with some
unique practical issues as a liquid ETF
holding a large stake in an illlquid
asset. But even more interesting to me
at least is that despite SpaceX
reportedly rising in value substantially
since this ETF invested in it back in
December 2024, the fund has lost money
in absolute terms and even more so
relative to the market. There are
multiple reasons for this and it gets
complicated quickly and that's part of
the problem. As Jeff Tac, managing
director for Morning Star Research
Services, widely noted in his analysis
of XOVR, 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. Investors are
so eager to get a piece of SpaceX that,
at least in this case, they got burned.
Some good news is that while it's
generally difficult to get access to the
private company shares that you really
want, a lot of public companies make
strategic investments into private
companies. Public market investors are
not entirely locked out of private
markets. Okay. What does all this mean
for you, the index fund investor? Yes,
it's possible that these upcoming mega
IPOs will affect market indices and the
index funds tracking them, especially if
these companies are fasttracked for
index inclusion. Due to index fund
mechanics, index funds will buy up IPO
shares that are included in the index at
any price, leading to adverse selection
and potentially even making the problem
worse for themselves as they bid the
price of the stocks up. If you're an
index fund investor already, this is a
cost you have been paying an implicit
cost. Maybe these cases are a bit more
extreme, but this is part of the
indexing lifestyle. You can either
accept it and carry on or look at
alternatives like dimensional funds that
are similarly lowcost and broadly
diversified but don't auto invest in
IPOs. No, you probably can't get access
to these private company shares prior to
their IPOs. When everyone wants to buy
something, either its price or the cost
of accessing it will absorb a huge
portion of the benefit you think you're
going to get from investing in it. If
you're interested in learning more about
how poorly IPOs perform, click here. Or
if you're interested in learning about
why PWL Capital uses dimensional funds
to construct client portfolios, you can
click right here.