To Infinity and Beyond...the Rules
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Key Capital Private, Investment Note #39
To Infinity and Beyond...the Rules
In late 19th-century Delhi, authorities offered a bounty for dead cobras to reduce the cobra population. Locals promptly began breeding cobras to claim the reward. When this was discovered and the scheme was cancelled, the now-worthless snakes were released, resulting in more cobras in the city than there had been to start with. While this story is just that - a story - ‘the Cobra Effect’ has become shorthand for policies that make the problem worse by incentivising the behaviour they were trying to eliminate.
The Nasdaq has new index inclusion rules that they believe will ensure the index continues to meet its core objective of representing the 100 largest non-financial companies, given the expectation of upcoming super-sized IPOs. One of these, SpaceX, is a rocket company (amongst other things) with a valuation that would make Buzz Lightyear's catchphrase feel conservative. However, perhaps not so outlandish, given the IPO filing claims 'the largest actionable total addressable market in human history' at $28.5 trillion.
The problem the new rules aim to address is the risk that a major equity index may become unrepresentative of the market it tracks. However, changing the index inclusion rules could be a classic example of the Cobra Effect, as the rules were designed to ensure newly listed companies with greater price volatility were not included. Now, being supersized is what gets you into the index, such that it will only be very large newly listed companies that will get included. At a circa $1.8 trillion valuation, SpaceX would be the 7th-largest company but 200th-largest by revenue (source: FT, May ‘26).
Index Origins
Charles Dow and Edward Jones launched the Dow Jones Industrial Average in 1896 to fill a gap that the 1890s industrial boom had made obvious: investors had no reliable way to read the market's overall direction. Dow's solution was twelve companies’ prices added together, divided by twelve.
Indexing has changed considerably since then, and with respect to Nasdaq, the exchange also operates the index. One of Nasdaq's most profitable revenue streams is licensing its index to ETF issuers and mutual funds. Exchanges compete aggressively for IPO mandates, not just for listing fees, but also for data revenues and, most importantly, trading volumes, which are supercharged by passive index-driven flows. Last year, Nasdaq lost three highly anticipated tech listings - Figma, Klarna, and Circle - to the New York Stock Exchange. Seen in that context, Nasdaq's decision to amend its eligibility criteria could be an attempt to win the upcoming mega-IPOs.
Tailored to Fit
Minimum free-float (the portion of a company's outstanding shares that is freely tradable on the open market by public investors) requirements for new listings have been scrapped. The waiting period for Nasdaq inclusion, which reflects the fact that when a company initially lists, the price can be volatile and price discovery takes time, has been cut from at least 3 months to just fifteen trading days. Finally, a new "modified market capitalisation" rule has been created to somewhat offset the elimination of the minimum free-float requirement. This applies to any company with less than a third of shares freely trading: for weighting purposes, that company is valued at three times its actual float.
SpaceX plans to bring approximately $86 billion of stock to market against an estimated $1.8 trillion valuation (Source: FT, May ‘26), a free float of roughly 4.8%. Under the old rules, that float would have disqualified the company from index membership entirely.
Actions Have Consequences
The scale of passive investing is what makes Nasdaq's rule changes significant. According to the Thinking Ahead Institute, investment in passive strategies now account for US$55 trillion of AUM that track indices. About 1% of this, or $523 billion, is in just two index tracking ETFs that track the NASDAQ 100.
Obviously, index inclusion drives passive buying; the cumulative effect of the rule changes is to amplify the amount of passive allocation to the newly listed companies beyond what would have occurred under the old rules. Given the expected level of demand, SpaceX's filing documents include a change to the standard 180-day lockup for some existing shareholders (Musk and other key shareholders are excluded). From the first post-IPO quarterly earnings release, insiders can begin selling in tranches - with a performance trigger that unlocks additional sales if the stock trades 30 per cent above the IPO price.
Index Inclusion and Passive Flows
Mike Green, who is sometimes referred to as the Cassandra of passive investing, addressed the index inclusion changes on the ‘On The Tape’ podcast. He believes that mechanical flows, rather than fundamentals, drive equity markets. Amending index inclusion rules to admit newly listed stocks alters what the passive bid is buying.
S&P Dow Jones Indices, which oversees the S&P 500 index, is reported to be considering changes that would allow SpaceX (and other IPOs) to bypass the standard 12-month seasoning period and relax the four-consecutive-quarters profitability requirement (source: Wall Street Journal).
The profitability filter has historically been the S&P 500's most meaningful quality screen.
Does the Score Still Reflect the Game?
Charles Dow built his index to give ordinary investors a reliable read on a market that was otherwise difficult to navigate. Today's index committees would argue they are doing exactly the same - simply responding to a change in the type and scale of companies going public.
But index inclusion rules incorporate safeguards to protect investors: seasoning periods to allow price stability, free float requirements to ensure liquidity and genuine price discovery, and profitability thresholds to focus on proven business models. These safeguards are being weakened.
Given the increasing importance of passive flows, these changes will help facilitate megacap IPO issuance at an unprecedented scale, with Goldman Sachs forecasting $225 billion of IPO gross proceeds in 2026, almost twice the previous record in 2021. The difference between the two is that in 2021 there were 251 company IPOs, whereas if 2026’s forecast is achieved, it will be with far fewer companies. It raises an uncomfortable question: Did the trillion-dollar unprofitable IPO create the pressure to change the index rules, or are the changes helping to facilitate the trillion-dollar unprofitable IPO?
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Key Capital Private 'Meet the Manager' Event - Brad Olsen from Recurrent Investment Advisors
Key Capital Private was pleased to host Brad Olsen, Co-Founder of Recurrent Investment Advisors and Portfolio Manager of the Recurrent Global Natural Resources Fund, for a timely discussion on energy, natural resources and portfolio diversification.
Please find attached a pdf of the slides, a couple of topic specific video edits and also the full video link.
Energy Security and Portfolios - 10 min Highlights
Real Picks & Shovels Investing - Full Presentation
Recurrent Event Slides:
This is a Marketing Communication provided for general information only. It does not constitute investment research, advice or recommendation.
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