Episode 406: When Massive Private Companies Go Public

22:33Ben Felix:And then there are a whole bunch of other criteria like that. Most major indices, as I just mentioned with Crisp, have a minimum float requirement, and they weight stocks by their public float. NASDAQ 100 is an exception to that, and we can talk more about that in a minute. But a company could go public while only making a small portion of their overall market capitalization freely available on public exchanges, which is often the case. Companies will tend to have 20 % to 30 % or something like that as a public float. Some of these companies, I mentioned the FT article, it's speculated that these companies are going to go public with low public floats, like as low as 5%.

23:09Ben Felix:As I mentioned before, at a $1.75 trillion valuation for SpaceX, total market valuation at a 5 % float, their weight in the eyes of indices is 88 billion, not 1.75 trillion. Pretty big difference. It's a huge difference. And it fundamentally changes the issue too, doesn't it? 100%. So when we're talking about, oh, these companies are so much bigger, this makes this issue magnified. Well, yes, if they floated 100 % of their equity, yeah, it's a huge difference. If they float 5%, it's a non-issue. If they float 10 % and they're able to enter the index at all, okay, now they're a whatever, one of the biggest companies that's ever existed.

23:46When investors are thinking SpaceX is going to have a big impact to the index, it may be you're fearing what the headlines are saying without actually understanding the actual implication.

23:57Ben Felix:Yes, but, and there is a but, so NASDAQ did change its rules, and I'm going to talk about that in a second. A lot of the headlines are about the index providers considering changing the rules to accommodate these big IPOs. But you're right, Ben, as of right now, this is actually not that much of an issue, unless you're investing in the NASDAQ 100, which you probably shouldn't be doing anyway. That's a whole other topic for another day. NASDAQ, when I originally wrote these notes down, they did have a 10 % minimum float, and they weighted stocks based on the value of all listed shares of the company with no regard for free float.

24:28Ben Felix:So that's pretty interesting. But they had this whole index consultation process, which some other index providers are also doing publicly. Like FTSE is in the process of a public consultation right now. They're requesting people to write in about potentially making changes to their indexes. S &P, as I mentioned, is apparently considering doing this, but they haven't made a public consultation as far as I know. So NASDAQ though was an outlier. So they did have a minimum float, which was not an outlier, but they valued for weighting companies in their index. They used the total capitalization with no regard for free float.

25:01Ben Felix:Now in their consultation, one of the things they changed, or well, a few of the things they changed, they did eliminate the minimum float. So now you can have a 1 % float and technically be included in the NASDAQ 100 index. And then they introduced a float factor in their weighting of low float stocks. I want to talk a little bit more about that because Dan, you and I were chatting about this before we started reporting. A lot of the speculation about NASDAQ making these changes was that they were trying to change things to increase the weight of low float companies in their index. But NASDAQ actually calls this out specifically in their concluding remarks, summarizing their consultation process.

25:41Ben Felix:So they say some respondents in their analysis of the impact appeared to assume that the index, that the NASDAQ 100 index is currently free float weighted. However, this does not reflect the current methodology. As noted in the consultation, index constituents are currently represented at the full market capitalization of eligible listed shares without regard to free float considerations. Accordingly to the proposed low float security weight adjustment, not to exceed the full listed market capitalization would represent a more conservative weighting approach than the one currently in place rather than the more aggressive one.

26:12Ben Felix:So they've limited the 10 % cutoff for minimum float. So it'll take any level of float, but they have adjusted the way that they weight securities to be more conservative for low float stocks, not more aggressive, which is different from a lot of the perception while they were in their consultation process. So it goes some way to reducing this enormous concentration. Right. We'll take your low float securities, but we're going to weight them more conservatively than we would wait a typical security. But they did change the rules and they did change them in a way that would allow companies like SpaceX to be included in the index, which would not have previously been possible.

26:52Ben Felix:They also sped up the inclusion. They shortened the timeline for how quickly a company, an eligible company can be included in the index. I mentioned earlier that the sort of cynical view here is that NASDAQ is changing the NASDAQ 100 index rules to win SpaceX over in an effort to get their listing. And there was a bunch of articles on that speculating this, and it's plausible, fine. That's because including a stock like SpaceX in the index would force significant index fund buying, which likely ends up being good for SpaceX, good for SpaceX's early investors, good for NASDAQ if they get the listing, but potentially comes at the expense of NASDAQ 100 index fund investors if they end up buying a high-priced stock that ends up having poor returns afterwards.

27:36Ben Felix:It's a conflict of interest that probably should be considered. I agree. It's a conflict, yeah. Now, we've already talked about this at some length, but the crisp US total market index, for example, tracked by VTI, does, as of now, continue to have a low float cutoff of 10 % for fast-track entry. If you're invested in VTI, this is a non-issue at the current moment in time. So between inclusion criteria and index weighting methodologies, there's quite a bit of uncertainty about how these mega IPOs will initially show up in indices. Over time, what tends to happen is the free flow tends to increase and whatever, whatever, and the seasoning happens.

28:12Ben Felix:So like in three years, all of these companies probably are included in the index, but the big concern about buying high priced IPOs in the secondary market and then having them tank, it's not clear how problematic that's going to be for a lot of index funds. Over a longer period of time, as I just mentioned, these listings will change the public market. To reiterate, that's why index providers are considering making these changes to get these companies represented in their indices sooner. Indices are meant to represent the stock market. So if all of a sudden there's this massive new company listed on the stock market, like, yeah, the indexes probably shouldn't hold it.

28:46Ben Felix:They're not designed to be investments. They're designed to represent the market. Putting that in context, this is pretty interesting. So there's a blog post from S &P where they show that SpaceX, OpenAI and Anthropics, those three of those big private companies, at the time of writing the post, which is fairly recent, those companies would make up 2.9 % of the S &P world index at their full market caps. So that's like full free float or just whatever, their full market cap. So that's almost as much as Canada, three companies, three newly listed companies, which is pretty crazy. As I just said, that was their total market cap.

29:22Ben Felix:So no consideration for free float. Now, since a lot of these companies are expected to have low public floats, I think that has to be accounted for in estimating their impact on the overall market. There's another post from MSCI where they calculate the potential changes to the MSCI All-Country World Investable Market Index in the event of some of these big companies going public in 2026. Now, this was written back in February 2026 when SpaceX, they had a modest valuation of only 800 billion. Now I mentioned it's expected to be 2 trillion. I think the general points are still relevant. Kind of crazy to whatever that is, two and a bit X their valuation in the course of a couple months.

29:59Ben Felix:That was pre the XAI acquisition. So part of that is just them acquiring XAI and their valuation increasing on that basis. But I think it's probably like a 2X even over that combined valuation anyway. So this blog post from MSCI asks, what would happen to the index, to this MSCI All-Country World IMI Index, IMI Investable Market Index, so it's pretty much all stocks that exist, what would happen to the index if the 10 largest companies from the MSCI All-Country Venture-Backed Private Company Index went public? Now they comment that since the free float at the time of listing is unknown, as of now, we'll know when they list, they go through a few different scenarios.

30:40Ben Felix:At a 5 % float, which again is what SpaceX is expected to go public with, only four of the 10 large private companies that they're looking at would actually achieve index inclusion based on MSCI's inclusion rules. So again, we come back to that case where not all of these companies would be index eligible. MSCI has different criteria than CRISP or S &P, but based on their rules, four of the 10 would be eligible at a 5 % float. At a 10 % float, seven of the 10 companies would achieve index inclusion, but they'd be pretty small weights in the index. And there's a chart that we can hopefully include in the video that shows the ranking of these companies in the market by size.

31:18Ben Felix:But what's interesting is that while the overall market weights in percentage terms would not be huge, even in a 25 % float scenario, MSCI finds that the dollar flows just for funds tracking MSCI indices would be huge with newly listed private companies receiving billions of dollars in investment and the largest existing public companies seeing billions in outflows. So I think those flows are really what matter to index fund investors. Because even a small percentage change, if it's billions of dollars changing, moving from one equity to another, that's what matters for the index funds who are being forced to buy and sell shares.

31:55Ben Felix:I think there are probably some interesting tax considerations here too. I don't know enough about how exactly that would play out with US listed ETFs because they do have some mechanisms to reduce tax, but this would be a lot of buying and selling. It'll be interesting to see how that plays out too. So just to recap, 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's likely going to be at a weight reflecting their public float, unless we're talking about the NASDAQ 100, which as of recently would use its newly adopted float factor, which again is more conservative than their previous methodology of using the total market capitalization.

32:31Ben Felix:So that's kind of where we're at. On your YouTube video, I noticed many comments about why their rules, if we're just going to go change them to include companies like this? What's your take on those questions? And the market changes. It's not normal. So take the S &P 500. Normally, a company that goes public, it wouldn't even be a consideration that that company may make it into the index because it wouldn't be big enough. It's the 500 leading companies in the US. Well, a newly listed company is not going to fit that criteria. But now we're in a world where, okay, companies are staying private longer.

33:07Ben Felix:They're going public when they're much bigger. I mean, if I'm S &P, yeah, I'd be considering making changes too. If you want to represent the 500 leading companies in the US market, well, just because it hasn't been listed long enough, I don't know if it makes sense to exclude it. Yeah, it's interesting. It makes sense. And these are massive companies in a very rare situation when they're at IPO time, I would expect. This is not a normal thing to see in the market. There have been some other changes. The one that comes to mind I can think of is the S &P TSX capped index that is a non-issue today.

33:46But the rule, I think it's probably still part of the index methodology in Canada that no company can represent more than 10 % of the index. And no company in Canada currently is very close to that. But that goes back to the old Nortel days in the late 90s, early 2000s, when one company represented more than 30 % of the index. And they said, we get it. The index is supposed to represent the market. But this is really a pretty egregious bit of poor diversification with a single company representing one third of the country. So we're going to put in this rule because it just seems sensible. Now, is it arbitrary?

34:27Maybe. Is it defensible? I think so. It's basically a circuit breaker. It's not really there to shape the index on an ongoing basis. It's just there as a guard in case something gets really inflated and presents an unusual concentration risk to index investors. It seems like it's kind of motivated by the same thing. The rules almost always work. But when some really strange situation comes about, and you've got an IPO valued at$2 trillion, something that's never happened before, that maybe it's worth at least questioning the original rules and tweaking them. That makes sense. I'm not saying that they're always going to make the right decisions, but it does seem reasonable to revisit them.

35:17Yeah, that makes sense. Don't just ignore something when a$2 trillion company is about to IPO. Pretty substantial event. For sure.

35:27Ben Felix:There's a couple of things that I want to add here. One is I'd be very interested, Dan, to see the S &P TSX composite and capped composite side by side, but free float adjusted. Because S &P didn't start float adjusting their indexes until 2005, I believe. I could imagine that Nortel would have had a lot of closely held shares. They had a lot of shares in their pension plan, for example. I'd be interested anyway. I wonder how much free float adjustments mitigate that concentration risk in the index. In other words, it would not have represented such a large share had they had that free float adjustment in place in the past.

36:08Yeah.

36:09Ben Felix:That's my hunch because that was in late 90s that that index concentration got so serious in Canada. And I know that they changed to float adjusted weights in 2005. On the idea of changing index methodologies, that's a huge one. S &P in 2004, they announced that in 2005, I believe, that they would start free floating. Prior to that, they were not using free float weights. I found an article about this from 2004. It's all focused on the sense of most index users is that float adjustment reduces the costs of running index funds and ETFs because stocks with less float and therefore less liquidity have lower weights in the index.

36:51Ben Felix:Index users also feel that basing the index on available shares instead of total shares means that the index is a better reflection of the market and through the market of the economy. I would agree with that. Shares that are not available to the public is not really what most of us mean by the market. The index is not supposed to represent the economy. It's supposed to represent the stock market. And the stock market doesn't really include shares that don't trade. That makes good sense. It's actually super interesting. I wish I'd looked at this earlier. In an October 2003 concept paper prior to announcing the decision to move to float adjustment, S &P highlighted reasons against the switch.

37:30Ben Felix:We looked at the academic and theoretical basis for indexing, but found no arguments for or against float adjustment, said Blitzer. Side note, David Blitzer was an early guest on this podcast when he was still with S &P before he retired. It's an episode worth checking out if you want to hear more about some of the inside baseball of how indexes are created and managed. This is more quote from David Blitzer. Increased interest in investing outside the US seems to have raised the awareness of float issues in foreign markets where cross holdings and strategic holdings by governments or founding families are more common than the US.

38:05Ben Felix:That's also interesting. On the topic of indexes make changes to reflect changes in the market. And I think as this article also points out, changes in how indexes are being used by investors. I think we heard about that when I was in New York and talked to Jim Rowley and Tim Edwards. They talked a little bit about this, just about how index providers and index fund providers work together to figure out what the index should look like. And then I also wanted to mention this episode is coming out the week after we had Tim Edwards on the podcast, who is the managing director and global head of index investment strategy at S &P.

38:41Ben Felix:So he also had a bunch of comments just on, I asked him about that, why would an index provider change to accommodate these big companies? And he had some interesting stuff to say. That was a big tangent there. Lots of fun though. Why does all this matter? Why do we care about index inclusion of IPOs? A big piece of understanding why we're even talking about this is understanding that investing in IPOs on a secondary market is one of the worst investment strategies that you could possibly employ. They 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.

39:18Ben Felix:getting an IPO allocation, especially in hot IPOs like this is really, really hard. And even if you get one, it's not going to be as big as you kind of hoped it would be. And then investing in the shares once they're listed on the public market has been rough to say the least. They're the sort of consistent pattern of IPO underperformance, even as a name, named by Jay Ritter, who's also been a guest on this podcast. They called it in a 1995 paper, the new issues puzzle. So they had looked at companies issuing stock. So this is IPOs, but also seasoned equity offerings. Companies issuing stock from 1970 to 1990 tended to be poor investments.

39:53Ben Felix:So in this paper, they find that investors in IPOs receive average returns of only 5 % per year, while similar listed firms return 12 % over the same period. So the paper notes that to achieve the same wealth five years later, an investor would have had to put 44 % more money into new issues in the sample than into established firms of the same size. Pretty crazy. And hope that they're right. And hope that they're right. Yeah, I guess that's true. You have to make that bet ahead of time without knowing the historical data on that particular investment. That is a good point. That's data ending in the 90s.

40:31Ben Felix:And there's a more recent 2019 study from Dimensional Fund Advisors, where they looked at the first year secondary market performance of more than 6 ,000 IPOs from 1991 to 2018. So that actually does pick up right where Jay Ritter's sample ends. And they find that a portfolio of IPOs generally underperform the market and the small cap index by about 2 % per year. The main exception is the 1992 to 2000 period, when the IPO portfolio outperformed the small cap index by about 1.1 % annually. and that was mainly due to IPOs consisting of small tech companies that their prices took off during the dot-com boom, but we all know what happened after that.

41:11Ben Felix:So it looks good for a bit, but not so good afterwards. If you sold in 2000, you did great. Correct. Exactly. If you timed the bubble perfectly. This dimensional study finds that the poor returns are largely explained by the factors in the Fama and French five-factor asset pricing model. The IPO portfolio behaves like a portfolio of small growth, low profitability, high investment stocks, also known as junk in AQR's language or small crap growth, as I've heard it called by some people. These are types of stocks that they're more volatile and they tend to lag behind the broader market. If you can choose to avoid them, you might want to.

41:48Ben Felix:A really interesting thing is that Dimensional's paper ends in 2018, but their finding is pretty easy to update and replicate because there are actually two ETFs that invest in IPOs. They invest in IPOs when they list and they hold them for three years and then sell them. There's the Renaissance IPO ETF, which exclusively invests in large US IPOs. And as I said, they hold them for three years and then sell them. It has underperformed VTI, which just tracks the total US market by more than six percentage points annualized since inception in October 2013. As expected, if you run a quick regression, which I did in Portfolio Visualizer, it behaves like a portfolio of small stocks with high prices, low profitability, and aggressive asset growth.

42:31Ben Felix:And then there's another one that has international stocks. This one has been listed since 2014. Its ticker is IPOS, which I think is quite a comical or unfortunate ticker choice. It's also underperformed by a wide margin relative to just an index. You can also see similar underperformance. If you look at Jay Ritter's data, his data from 1980 to 2023 shows similar underperformance. So that's just a broad picture of IPO data. There are different ways you can slice it. And I'll talk about that from a couple of different perspectives in a minute. But first I want to talk about low float IPOs. Before I do that, do you guys have any comments?

43:04It seems to me your strategy, Ben, is buy the index, short the IPO ETF. That's not investment advice. It's just an observation.

43:12Ben Felix:Not bad. Maybe Mark McGrath can do that in his son's, whatever that is, RESP. Triple leveraged in his RESP. I'll send him a message. He's got a new idea. More realistically, and I'll talk about Dimensional the second. Dimensional just excludes those types of stocks. It's even more nuanced than that because not all IPOs are necessarily bad. Let me keep going in the flow that I have this written down. So those are IPOs. They kind of suck as investments in the secondary market. They're great if you're a holder of the private company shares. They're great initially. The problem for employees of companies is they tend to have lockup periods.

43:44Ben Felix:If you have to wait whatever, a long period of time, you don't usually get to participate in that pop. But if you held the shares and for whatever reason, don't have a lockup, the IPO is kind of great. But if you're buying in the secondary market, not as great. Low float IPOs. So we talked earlier about what float means. SpaceX is probably going to go public with a low public float and some of the other companies may also do something similar. If we look at low float IPOs in particular, the data look particularly bad. So just to reiterate from earlier, a low float IPO means that only a small portion of the company's shares are available for public trading.

44:19Ben Felix:And that can amplify price swings because demand is concentrated on a relatively limited supply. That's kind of what we're expecting to see from some of these big private companies. There's another way to slice that out of here that's important. Low float IPOs for high revenue companies, because SpaceX and OpenAI, they are generating large revenues. So low float, high revenue or high sales is pretty rare, but not unheard of. I have been emailing with Professor Jay Ritter about this for a bit now. He did send me a table that we can show in the video. I saw Bloomberg report on these data, but I hadn't seen the table anywhere.

44:53Ben Felix:So I'm pretty sure that our viewers here are getting a pretty exclusive look at some neat data. So Professor Ritter found 11 low float. So again, below 5 % public float, IPOs for companies with inflation adjusted trailing 12 month sales of 100 million or more. 10 of the 11 IPOs underperformed the market within three years with average underperformance of roughly 50 % relative to the market from the offer price and 60 % from the first day close. So we see there actually was a pop because if you bought it first day close, you did worse. It doesn't look good. It looks worse than the average IPO. Now, when I was emailing with Professor Ritter, he also mentioned that these examples, yes, they had low floats.

45:32Ben Felix:They also tended to have high price to sales ratios at the time of the IPO. Now, again, that's relevant for these current potential mega IPOs. If SpaceX were to achieve its$1.75 trillion valuation, let alone its$2 trillion valuation that I've seen more recently, it would have a price to sales ratio of more than 100 times based on trailing sales. Wild. Now, why does that matter? Professor Ritter also showed, and this is one of the things that's not in my video on this, Professor Ritter also showed me the data for all IPOs, So not just low float IPOs anymore, all IPOs sorted on their price to sales ratio.

46:07Ben Felix:Measured from the first close, the market adjusted three-year buy and hold return decreases with an increasing price to sales ratio for IPOs of companies with sales over 100 million. No surprise, I guess, valuations matter even for IPOs. What does the price to sales of 100 times mean? Just for context, the highest price to sales ratio for a public S &P 500 constituent is Palantir, which at the time that I wrote these notes had 73 time ratio, price to sales of 73. The index as a whole, the S &P 500 trades at a price to sales of 3.1 times. Now in general, as listeners know, high valuations are associated with low expected returns.

46:46Ben Felix:And these current private companies seem to have very high valuations or are expecting very high valuations when they list. For index fund investors, the problem is pretty complicated. Large private companies go public with high valuations. They're going to change the landscape of the broader market. Now in response, we've talked about indices have to rebalance to remain reflective of the broader market. That's why they exist. Market cap weighted indices will rebalance in response to stock market composition changes, which includes a whole bunch of things, including buybacks and seasoned equity offerings, as I mentioned earlier, but also IPOs.

47:19Ben Felix:In making those changes, indexes and index funds, they're implicitly engaging in a form of market timing. That language comes from Marco Salmon's paper on this topic. It tends to be really bad market timing though. And again, as we talked about earlier, the issuers, the companies that are listing on the public market, they'll generally want to issue stock when their own company's valuation is high and buy back stock when their company valuation is low. Indexes and index funds, because they're always to track indices that reflect the market, end up systematically buying high and selling low at the margins.

47:54Ben Felix:I want to reiterate, this isn't not a death blow for index funds. It's just a thing. I'll put a number to it in a second. So in Marco Sammons 2025 paper, which is now published in the journal of financial economics, which is pretty cool. We had him on before it was published to talk about it. Index rebalancing and stock market composition do indexes time the market is the paper. It estimates that that adverse selection is what he called it in an earlier draft of the paper, but that market timing ends up creating a performance drag of between 47 and 70 basis points per year relative to a delayed rebalancing approach that waits like 12 months, for example, to reflect changes in market composition.

48:30Ben Felix:So there is like a lasting negative effect on index fund returns that could be avoided if index funds delayed rebalancing, if they prioritized expected returns rather than tracking or to an index. If an index did this, they'd have massive tracking error to the index. I mean, be an index fund basically at that point. And that tracking error would be sad. As listeners know, I'm a huge fan of index funds, but as listeners also know, we don't use them. The assets that I oversee at PWL, we use dimensional funds rather than index funds. I personally don't invest in market cap weighted index funds. And this is, I mean, there are a bunch of reasons for that, but this is one of them.

49:06Ben Felix:Dimensional waits six to 12 months after a company lists before considering including it in their portfolios. Dimensional also intentionally tilts away from what I call the junk earlier that IPOs tend to behave like more generally. PWL uses dimensional funds, but they are not paying us to say this. I gain nothing from people using dimensional products. They have ETFs in the US and their competitor Advantis, which I'll talk about in a second, has products in Canada. So I mean, this is not intended to be like a sales pitch. It's just there's a company doing this a different way. So that's dimensional.

49:40Ben Felix:They wait six to 12 months to include IPOs. It's more complicated than that because they also tilt toward smaller and lower price companies, which have in many cases, and particularly in the US, underperformed. So even if we can say, well, hey, Dimensional didn't pay the IPO inefficiency cost in the US market, at least they did underperform because they tilted away from the large stocks that did really well over the last 20 years. Anyway, it's complicated. Yeah. And as the tireless defender of traditional index funds, again, worth pointing out is that no one's arguing that any of these strategies is free of those structural inefficiencies.

50:15And very often you're just exchanging one set for another when you change investment strategies based on relatively small things like how you wait in index. These are fairly subtle changes. Sometimes they eliminate some problems and just introduce others.

50:33Ben Felix:There's a play on words there. How you wait and how you wait. That's right. The waiting is the hardest part, as they say. I agree, Dan. And I do want to reiterate, this is not intended to say index funds are bad. It's just, this is just part of the indexing lifestyle. It's a cost. People are worried about this right now because of these big potential IPOs, but this is a cost that index funds have been paying. I don't know for how long. I think Marco's data in that paper goes back to 1980, if I remember correctly. It's there, it exists, but index funds have still outperformed pretty much everything.

51:07Ben Felix:How bad is it really? In my video on this, I mentioned Dimensional as doing things in a way that intentionally avoids the cost that we're talking about with IPOs, which introduces other trade-offs, as you just mentioned, Dan. I got a ton of questions about Avantis. If I did not mention them in the video, frankly, I did not know how they dealt with IPOs when I recorded the video and I didn't have time to reach out. But I got that question so many times that I reached out to them and just asked. I had assumed that it was pretty similar to what Dimensional does. dimensional. Again, they wait six to 12 months and then they incorporate the newly listed security after that.

51:41Ben Felix:Avantis, to my surprise, has no problem including newly listed companies and portfolios if they have enough information on their full set of financials and they trade at attractive prices relative to those financials. And they also mentioned that, well, the aggregate IPO data that we just talked about is terrible. If you sort IPOs on profitability, the more profitable ones aren't so bad. So if you're investing in negative earnings stocks and IPO, yeah, you did poorly. But if you sort by profitability, the more profitable stocks, that shows up in Professor Ritter's data too. That was interesting.

52:15Ben Felix:That surprised me. So they are really just looking at expected returns more so than a blanket exclusion of IPOs. They also noted when we were chatting about this, that they are totally aware of the issues surrounding index inclusion post-IPO. And so they try not to be on the same side of indices when they're buying and selling. They try to be on the opposite side or stay neutral during the rebalancing period. That was interesting. They have their own way of dealing with IPOs, but they're not doing a blanket exclusion or waiting period in the way that Dimensional does. In summary, there's three different strategies that each come with their own trade-offs and no one way is necessarily more right or wrong than the other.

52:52It's just trade-off that investors have to accept.

52:55Ben Felix:They'll all introduce their own tracking error, whatever you want to call it. they'll introduce performance differences relative to each other. If we held all else equal, but just had one fund that's going to invest in IPOs within five days, one fund that's going to wait six, 12 months, and one fund that is going to do what Aventus does, all else equal and just let the IPOs be different. They'd be pretty meaningful tracking error, more than any fee differences across the funds, which comes back to the question for the investor. Marco talks about this in his paper too, knowing that you're going to introduce tracking error from doing something, you have to have a lot of conviction, knowing that you can live with track mirror, that the expected long-term outcome is good, which is an interesting question because in the short term, there's going to be a lot of noise.

53:35Ben Felix:Excluding IPOs might look really bad over some periods. I mean, even in the, we'll show the chart for that IPO ETF, there was a period where it was outperforming. And so if you're excluding IPOs during that period, you're going to look at your decision and be like, man, I was wrong. But I think you have to think about what is the long-term expected outcome of this thing. And then acknowledge that because we're dealing with a ton of uncertainty in financial markets in the short term, there's going to be a lot of noise and you have to be able to stick through whatever you have decided to do through the noise.

53:59Ben Felix:And I think that applies to somebody choosing to use dimensional funds. It applies to somebody using index funds. It applies right now where people are worried about all these IPOs, but like, man, if you've been investing in index funds, you've been exposed to this exact thing. And now just because it's a big headline is not a reason to bail on the strategy. This comes up all the time. Investor discipline is key. There's so much noise that comes up. Right now we're talking about these mega IPOs, but tomorrow would be something different. Next week, next month will be something different than that.

54:29But if you're constantly looking for the edge or the downside to protect against, you're probably going to end up worse off if you keep changing and adjusting your strategy. It's better just remain disciplined to a tried and true strategy that you're committed to for the long term.

54:44Ben Felix:Agreed. The last little segment I have here is index funds in private markets. with companies staying private longer and going public when they're larger. I think it's a natural question to ask whether investors should be seeking exposure to private company shares before the companies go public. I think 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 AI, which are dominating headlines today, there are thousands of companies that did not grow or failed entirely. That skewness exists in public markets too, but it's way more brutal in private markets.

55:18Ben Felix:It's really easy to look back right now and say, oh, I should have bought SpaceX shares. You probably couldn't have, but I wish I found a way to get SpaceX. But there are a ton of private companies that failed over the same period, over the time that SpaceX has been operating and grown to its current size, including other space companies. It's tough out there. And another big thing is that the fees and costs associated, and we talked about this in a lot of detail in a previous episode, the fees and costs associated with private company investments can often absorb the financial benefits of owning private assets.

55:48Ben Felix:As we've talked about, that has largely been true with private equity funds in general, which have delivered net of fee returns roughly in line with public markets, especially when they're properly matched to comparable public equities. There are some really interesting stories floating around right now about the length that some people have gone to, to buy what they hope are SpaceX shares. So there are these things called special purpose vehicles that get created in order to pool investor money together and buy private company shares. Private companies don't want hundreds of investors on their cap table.

56:20Ben Felix:So a special purpose vehicle can pool a bunch of money together. So there's just one entity that's buying shares. So there's one special purpose vehicle reported on by the Wall Street Journal that had a 4 % upfront fee with an additional fee of 25 % of future profits when the shares are sold. You can get exposure to the shares through this SPV, but how much of the benefits are you actually going to keep? One of the other things that comes up is that there are questions about who actually owns what because the special purpose vehicle structures and layers of ownership are so complicated that it's hard to know what you actually own.

56:57Ben Felix:And then there are also stories of just outright fraud in some of this reporting where people were saying they could get access to some of these private company shares and they were actually just stealing the money. which hopefully is not too common. It's out there. Anytime there's something people really want, I think it will create a vector for fraud. People will see something like SpaceX. They'll imagine all the money they can make if they were able to buy some SpaceX shares or whatever company shares at a low valuation and then sell when it goes public, which is true if you can do that. Yes.

57:26Ben Felix:But unless you're an employee or otherwise have direct access to the company's shares, early and direct access to the company's shares, financial intermediaries that do have access or able to get access are not typically going to give you, the end investor, access to an equity like that on terms that are better for you than they are for the intermediary selling them to you. Financial intermediaries, they don't tend to be in business to give you the investor money for free. There are some pretty interesting stories about ETFs that have gotten exposure to SpaceX. There are some, like Fidelity. There are a couple of fund companies, active managers, who legitimately participate in fundraising and were able to invest in some of these companies early, which is pretty cool.

58:07Ben Felix:It'll be interesting to see how that affects the returns of those funds because obviously this isn't their only holding. We'll keep an eye on that. But there are some ETFs that tried to get exposure through special purpose vehicles later on. So there's one ETF that attracted quite a bit of reporting and attention. The ER shares private public crossover ETF. So it bought into SpaceX through an SPV in December, 2024. Now SPVs are not liquid, not very liquid at least. So this ETF, it's XOVR, I think is the ticker. It's had to deal with some pretty unique practical issues because it's a liquid vehicle.

58:44Ben Felix:It's an ETF holding a large stake in an illiquid asset. So Jeff Tack from Morningstar has done a bunch of interesting writing on this. What's even more interesting though, at least to me, is that despite SpaceX reportedly of the rising in value substantially since this ETF invested in it in December, 2024, the fund has actually lost money in absolute terms, and even more so relative to the market since it made that investment. There's a whole bunch of reason for this. And Jeff Tack goes through a bunch of the reasons in an article. A lot of it is just that the other securities, the public securities that are in the ETF have performed quite poorly.

59:18Ben Felix:Jeff Tack, he's the managing director for Morningstar Research Services. People don't know who he is. he wisely notes in one of his posts on this, that 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. I think a lot of investors are so eager to get a piece of SpaceX and some of these other companies. In this case of this ETF XOVR, they got burned. They ended up losing some good news. And then this is also quite interesting is that, well, it's generally difficult to get access to the private company shares that you want.

59:50Ben Felix:A lot of public companies will make strategic investments into private companies. From that perspective, public market investors are not entirely locked out of private markets. Google invested in SpaceX in 2015. More recently, EchoStar received SpaceX stock as part of a deal for wireless spectrum. Amazon, Microsoft, and NVIDIA are major investors in OpenAI. There was a leak of OpenAI's cap table. Microsoft owns a huge portion of their equity. I don't know, man. The hottest private companies, in many cases, public companies who saw potential in that now hot private company have invested in them.

1:00:26Ben Felix:And so if you're a public market investor, you're indirectly or not even indirectly, like you're participating in some of those private market successes before they trade on public markets. I think Microsoft stock actually popped on. It was an open AI announcement about their valuation, I think. It's there. if you're not totally locked out of private market growth. Yeah, it just shows the power of sales and marketing. When you hear about these different offerings, fund managers are actually just preying on the desires and interests of investors and creating products that make it sound attractive, but they're either high fees, hard to access, or like this ETF you give an example of, are going to result in an undesirable outcome.

1:01:13Obviously not guaranteed. Some people get lucky, but product manufacturers design things like this in a way to profit themselves. Sometimes it benefits the investors, but unless you pick the right one at the right time, you're probably going to be worse off. I think this is a really good reminder too, that when you own the whole market, you don't have to worry too much about FOMO because I'd made this argument with people before who say, you know, they want to diversify more by buying crypto or AI plays or whatever it is, even real estate. These are things that are not necessarily directly represented in the index, but they are indirectly just by, well, I said a minute ago or earlier in the episode that the index isn't really designed to represent the economy.

1:02:05It's designed to represent the stock market. The stock market is a proxy for the economy. It doesn't always map it directly, but the idea is to this point here, if you own the total market, you already own a big chunk of Amazon, Microsoft, and NVIDIA, and therefore you also own a big chunk of OpenAI. There's not a lot more you can do other than own virtually every public company that's available. And when you do that, you know, by trickle down, sort of own a little bit of just about everything. As long as you're okay with that, yeah, sure you can over concentrate in one or the other stock or sector.

1:02:44But if you just want a little bit of exposure to everything, buying the total market index is still the best way to do that.

1:02:51Ben Felix:I agree. Microsoft owns a huge portion of OpenAI. Does it make sense for you to go out and try your best to find a way to buy more OpenAI? Do you need to own more than what is represented by Microsoft? I mean, I don't know. I guess after the fact now, if you knew to do that a while ago, we can say that, hey, that would have made a lot of sense. But again, as I mentioned earlier, there's a ton of survivorship bias there. Go back in time 10 years, which private companies should we invest in? I don't know, man. Not so easy. It's hard enough to pick public companies. It's harder to pick private ones where there's less information available to make those decisions.

1:03:24All right.

1:03:25Ben Felix:So my wrap up here, yes, it is possible that these upcoming mega IPOs will affect market indices, especially if these companies end up being fast-tracked for inclusion. And then due to index fund mechanics, index funds will buy up IPO shares at any price, if they're included in the index they're tracking, leading to adverse selection and potentially even making the problem worse for themselves because people know the index funds are going to be buying those shares. If you're an index fund investor, I think this is a really important point. This is a cost that you have been paying and still outperformed most everything.

1:04:00Ben Felix:Maybe these cases, as you mentioned earlier, Dan, are a bit more extreme just because of the size of the companies, but this is it. This is part of the indexing lifestyle. You're deciding to accept what the public market has to offer, which includes investing in IPOs that sometimes have high prices. You can either accept that and carry on, which has been a very successful strategy. I suspect it will continue to be a very successful strategy in the future. Or you can look at alternatives like dimensional funds or Avantis funds that we talked about, which have their different methodologies for avoiding IPO flops.

1:04:33Ben Felix:And those are also low cost, broadly diversified systematic funds. They just have their various ways of not auto investing in IPOs at any price. And then the last piece is, no, you probably can't get access to these private companies directly prior to the IPO. You can try and get an IPO allocation. When everyone wants to buy something, either its price or the cost of accessing it is going to absorb a huge portion of the benefit that you think you're going to get from investing in it. And then as we talked about, you've already got exposure to a lot of this stuff through public companies that have invested in those private companies already.

1:05:06That's it. Good discussion. And I think a nice elaboration on the original video. I think we took it in a few different directions that were pretty productive. it.

1:05:15Ben Felix:Well, it helps a lot having you guys here to chat with. So I think about that. Is it repetitive to have the same topic on my channel where I just talk about it myself and then also on the podcast, but even setting aside additions, like the additional information from Avantis and Professor Ritter, I think having you guys giving your commentary and interpretations as we're going through the topic, it just makes it way more interesting and adds a ton of elements I don't have on my own. By the time you've released the video and we record this episode, there's already a bunch of comments on the YouTube video or in the channel that prompts new thinking and questions or clarifications.

1:05:50So it's worthwhile. And not everybody listens to both. It's another important point.

1:05:54Ben Felix:True.

1:05:59Ben Felix:We do have one review. I'll read the disclaimer. Do you want to read the review, Dan? Sure. We have a review from Apple Podcasts to read. Under SEC regulations, we are required to disclose whether a review, which may be interpreted as a testimonial, was left by a client, whether any direct or indirect compensation was paid for the review, or whether there are any conflicts of interest related to the review. As reviews are generally anonymous, we are unable to verify if the reviewer is a client or disclose any such conflicts of interest, which there won't be because we don't pay for reviews. All right.

1:06:31So this one is titled, Valuable and Insightful Podcast. Love the podcast and always find the uninterrupted time to listen for content. Not being a finance nerd, I find some of the topics over my head, but over time, my understanding is improving. I appreciate the scientific approach, and listening always puts me in a higher thinking mindset. I love the rent, buy, and happiness index type topics as well. The banter before and after is great, and I really like to hear what Cameron is up to. His gentle nudges for Ben to share are always entertaining. Shout out to Mark. I really caught onto his dry wit and felt he was a great addition.

1:07:09All the hosts are great, keep striving for topics from a Canadian perspective as we all get more US influence. I will say that the disclaimer we're all waiting for has mainly overstayed its welcome at this point. I can listen to the factual one without skipping, but the fun one is only good for a couple of listens. It's fair enough. Could be time for an in-between version for those who can't easily skip it. Just my opinion. I've also tried to watch the YouTube, but maybe all my team's meetings at work have soured me on this format for your content. That being said, the positive educational and informational benefits of your content far outweigh any of my critiques.

1:07:45I will continue to be a fan of Ben, Cameron, and company for as long as we have the privilege to keep learning and listening. Thank you for such great shows. From Jeff in IT from Aurelia.

1:07:56Ben Felix:This is a new review and Cameron's barely in the podcast anymore. He very much has gone back to older episodes. But another shout out to Mark. So we got him into the episode a couple of times today. Mark and his lasting impact on the podcast. Indeed. All right. That's all I have. Anything else from you guys? Oh, see you next time. Thanks everyone for listening. And thanks guys.

1:08:21Hey everyone, it's producer Matt. Thank you so much for tuning in to this week's episode. Before we sign off, here's the disclaimer you've been waiting for. Portfolio management and brokerage services in Canada are offered exclusively by PWL Capital, which is regulated by the Canadian Investment Regulatory Organization and is a member of the Canadian Investor Protection Fund. Investment advisory services in the United States of America are offered exclusively by One Digital Investment Advisors, LLC. One Digital and PWL Capital are affiliated entities, and they mostly get on really well with each other.

1:08:54However, each company has financial responsibility for only its own products and services. Nothing herein constitutes an offer or solicitation to buy or sell any security. Occasionally, we tell you not to buy crappy investments in the first place, but that's not the same thing as telling you to sell them. This communication is distributed for informational purposes only. The information contained herein has been derived from sources believed to be truthy, but not necessarily accurate. We really do try, but we can't make any guarantees. Even if nothing we say is fundamentally wrong, it might not be the whole story.

1:09:29Furthermore, nothing herein should be construed as investment, tax, or legal advice. Even though we call the podcast your weekly reality check on sensible investing and financial decision making, you shouldn't rely on us when making actual decisions, only hypothetical ones. Different types of investments and investment strategies have varying degrees of risk and are not suitable for all investors. You should consult with a professional advisor to see how the information contained herein may apply to your individual circumstances. It might not apply at all. Honestly, you can probably ignore most of it.

1:10:01All market indices discussed are unmanaged, do not incur management fees, and cannot be invested indirectly. Which is a shame, because it would be awesome if you could. All investing involves risk of loss, including loss of money, loss of sleep, loss of hair, and loss of reputation. Nothing herein should be construed as a guarantee of any specific outcome or profit. Past performance is not indicative of or a guarantee of future results. If it were, it would be much easier to be a Leafs fan. All statements and opinions presented herein are those of the individual hosts and or guests and are current only as of this communication's original publication date.

1:10:42No one should be surprised if they have all since recanted. Neither OneDigital nor PWL Capital has any obligation to provide revised statements and or opinions in the event of changed circumstances. See you next time.