By Michael Wursthorn

Apartment Investment & Management Co. will exit the S&P 500 to make room for Tesla Inc., setting the stage for the biggest-ever single-stock addition to the index.

The swap is due to take effect before the start of trading Dec. 21, according to S&P Dow Jones Indices, which outlined plans for the substitution late Friday.

Changes to the index are usually a mundane affair. But in the case of Tesla, the switch isn't as simple as buying one stock and selling another for the fund managers who track the index.

With a market value of about $578 billion, Tesla will be the sixth-biggest company in the S&P 500 and the largest stock ever added to the index. Fund managers and analysts anticipate more than $100 billion in stock will change hands Dec. 18 to account for the swap. More than $4 trillion is linked to the S&P 500 through index-tracking mutual funds and exchange-traded funds.

By the end of that process, the millions of Americans who own shares of index funds will suddenly have a claim on a piece of the most valuable car company in the world. Tesla's market cap is more than double the combined values of Toyota Motor Corp., General Motors Co., Ford Motor Co. and Fiat Chrysler Automobiles NV.

Tesla shares have skyrocketed this year, up more than 600%, with a substantial chunk of those gains coming after S&P initially unveiled its plan to add the electric-car maker to the index last month. Individual investors and fund managers who actively buy stocks pounced on the news, anticipating a surge in demand that would push Tesla shares even higher. Goldman Sachs Group Inc. analysts initially said such activity would send Tesla shares to $600 by the inclusion date. But shares have already blown past that estimate, closing Friday at nearly $610.

The decision to remove Apartment Investment & Management, or Aimco, coincides with the company's decision to spin off a significant chunk of its assets into a new real-estate investment trust, Apartment Income REIT. That process is expected to be completed Monday.

Aimco's shares are down 37% this year, putting its market value at $6.5 billion.

The real-estate investment trust, which owns apartment complexes across the U.S., wasn't among the likely candidates analysts had identified for removal. Many had speculated that S&P would cut from among the smallest companies in the index. Possible candidates were seen as Xerox Holdings Corp., Hanesbrands Inc. and SL Green Realty Corp. -- all of which have market values below $5 billion. A stock in the energy sector was viewed as another possibility due to the group's struggles this year.

Tesla's addition to the S&P 500 has turned the usually banal process of rebalancing the index on its head. Typically, S&P announces what is going into the index and what is coming out, giving fund managers a couple of weeks of lead time to prepare for the changes. This time, S&P has broken up and lengthened the process to account for the massive sum of money that will be put in motion.

S&P's initial announcement about Tesla's inclusion didn't include any mention of how it would work or what company it would replace. The company opted to poll investors on whether to add Tesla's full weighting to the index at once or over two trading days, before settling on a single tranche. The final piece of the puzzle was which stock would be removed.

"In a normal situation, we wouldn't do that," said Howard Silverblatt, a senior index analyst who says he has seen plenty of rebalancings over his 44 years at S&P Dow Jones Indices. "But there will be an enormous amount of trading."

Based on where Tesla shares have been trading, Mr. Silverblatt estimates index funds will have to buy more than $80 billion of Tesla stock -- a number backed up by several fund managers and traders. Index funds will have to sell that same amount of stock, including shares of Aimco, along with trimming their positions in most of the other stocks in the S&P 500. Tesla is expected to enter the index with a weighing of more than 1%.

"There will be a lot of moving parts around that funding trade," said Greg Sutton, head of portfolio trading at Citadel Securities LLC. "You'll likely see dislocation among the bottom tier of S&P 500 stocks, which are a little less liquid."

S&P is timing Tesla's inclusion to coincide with its quarterly rebalancing of the index, an event that readjusts the sizes of all the stocks in the S&P 500. That typically adds billions of dollars in additional liquidity to the market, Mr. Silberblatt said. An event known as quadruple witching takes place the same day, when options and futures on both indexes and stocks expire simultaneously, putting more cash in play.

But even with the additional liquidity, Mr. Silverblatt says there will be a historic level of trading that will leave a powerful mark on the S&P 500. The last rebalance of the index in September amounted to some $35 billion in trading, he added. The most ever was in 2018, with more than $50 billion.

More important, Tesla will have an immediate noticeable impact on the market-cap-weighted S&P 500. The company doesn't pay a dividend, so it will bring the S&P 500's payout ratio down to 1.54% from 1.56%, Mr. Silverblatt said based on recent figures. The index's forward-looking price/earnings ratio will climb to 22.4 from 22.1.

For every $11 Tesla moves, the S&P 500 will gain or lose a point, he added, potentially making the index itself more volatile.

"Tesla was volatile before we put it in. And it's volatile now," Mr. Silverblatt said. "For better or worse, it's going to have an impact."

(END) Dow Jones Newswires

12-11-20 1820ET