[energy123]

You protect yourself by understanding that this is one infinitesimally small cost (expressed as a fraction of your portfolio returns) that doesn't overcome the benefits of maximum diversification and the ultra-low fees of broad-based ETFs.

Buy MSCI World, enjoy the 0.04% p.a. fees and minimal idiosyncratic risk, and relax.

Index rebalance traders will reduce your annual returns by less (probably much less) than 0.1%, but there is no better alternative for you at this moment in time.

[eru]

I broadly agree. Though I'm less pessimistic: lots of people will pay lots of attention to SpaceX and friends, and with short selling in public markets being possible, an accurate price will be established very quickly.

Remember also: index funds are some of the participants most keen to lend out their shares to short sellers. It's one of the rare ways they can boost returns above the raw index they follow.

[OskarS]

> and with short selling in public markets being possible, an accurate price will be established very quickly.

I know very little about markets, but: aren't the short-sellers just going to provide liquidity for the big index funds? Like, if the funds HAVE to buy SpaceX, and the funds are enormous, wont every single stock sold short be immediately gobbled up, as well as pretty much anyone else wanting to sell? Even if everyone else is selling like mad, it wont affect price much at all?

Maybe this is naive, but if these enormous funds are more or less forced to buy SpaceX, it seems impossible that "actual price discovery" is going to happen in any reasonable amount of time, and the short-sellers will be screwed.

[eru]

Most index funds, and essentially all that matter economically, hold stock in proportion to the free float, and not the total market capitalisation. See https://en.wikipedia.org/wiki/Public_float

So if SpaceX only sells 1% of shares in the IPO, and the rest are locked up, then these index funds will only try to buy some fraction of this 1%.

For simplicity, let's assume about 25% of stocks by value are held by index funds. In our case, that would mean that index funds would buy 25% of 1% of SpaceX, or about 0.25% of SpaceX's market capitalisation. For simplicity, assume a SpaceX market capitalisation of 2 trillion USD, so that would be 5 billion USD. A big sum for you and me, but not all that much too worry about for the index fund industry and the stock market.

Later on, the lock ups will be lifted. That will increase SpaceX's weight in the relevant indices, but will also make sure that more stock is available to buy for them.

About the impact of short sellers: let me construct an exaggerated cartoon example. Suppose our index fund already has a 100 shares of SpaceX and wants to hold 300 more, but no else who holds SpaceX is currently allowed to sell for another three months.

Well, index funds are really, really keen on lending out shares to get a bit of extra revenue. So the index funds lends out 100 shares. They go to a short seller, who immediately sells them back on the exchange, where the index fund buys them. Now the index fund has exposure to 200 shares. 100 'real' shares it just bought, and 100 shares that the short sellers owes them. Well, the index fund can lend out the 100 real shares again, and repeat the cycle 2 more times, so that at the end they have 300 lend out shares and 100 real shares on their books.

In three months the lockups expire, and the short seller closes out their short position.

The above is an exaggerated stylised cartoon description, but it's not too far off what can happen in principle.

Well, the index fund would lend out the 100 'real' shares they have at the end, too, just to collect a bit of extra borrow fee on another 100 shares. So the index fund has an economic claim to 400 lend out shares, and doesn't currently hold any physical shares.

Other market participants can trade these 100 physical shares back and forth amongst each other (or loan them to each other, too) to help with price discovery.

There's also stock futures, where you trade the right/obligation to transact some shares at specific prices in the future. Economically, entering into a contract today to be obliged to sell shares in the future is equivalent to becoming a short-seller, but for regulatory reason you don't need to borrow the shares when selling futures.

So stock futures are another way to help with price discovery, even when there's scarcely any underlying shares available right now.

[OskarS]

That’s a really great explanation, I think I more or less followed all of it. Thanks for taking the time to write it out!

[rrrrrrrrrrrryan]

> with short selling in public markets being possible, an accurate price will be established very quickly

It'll be virtually impossible to short sell the stock within the first month due to lockups, and it'll take 180 days for all the pools to be available: then, we'll have a more-or-less "accurate" price, as you put it.

[eru]

Whatever float is available on the market can be made available for short sellers to borrow. That can even happen multiple times: ie short interest can exceed 100% of the float. Or even 100% of the market capitalisation.

With stock futures, you don't even need to borrow the stock to (effectively) short it: anyone with enough collateral can write stock futures, whether they own the underlying stock or not.

[ddalex]

> understanding that this is one infinitesimally small cost

They are stealing your money with make believe numbers, but just suck it up.