Will Index Buyers Rescue Facebook?

The Facebook (Nasdaq: FB  ) IPO has inspired more scorn and derision than most people ever would have imagined before its first shares traded last month. Just a few weeks in, and after billions of dollars in losses, millions of those who once dreamed of owning the stock now probably want nothing to do with it.

Yet many of those investors could well see part of their fortunes tied to the social-media giant before the month is out. With the annual rebalancing of the Russell indexes, Facebook stands to gain a place among some of the most-followed indexes in the world -- and after the changes take effect, index funds that you own could well hold Facebook shares.

Why you'll own Facebook
Index funds give you a cheap, easy way to invest. By having you own a portion of every single member of a given index, you'll get a diversified set of investments that includes companies from every corner of the market.

But as I pointed out back in February shortly after Facebook announced its IPO, index funds are slaves to the indexes they track. So as newly public stocks qualify for inclusion in various indexes, the funds that track those indexes will have no choice but to buy shares.

Russell's annual June rebalancing makes it the first major index to pick up Facebook. In addition to the social-media company, the Russell 1000 index of large-cap stocks will also likely include payment processing company Vantiv (Nasdaq: VNTV  ) , which Fifth Third spun off in 2009, and Allison Transmission Holdings (Nasdaq: ALSN  ) , which produces truck and bus transmissions. Yet neither of those companies has the size or public awareness that Facebook has.

Much ado about little
Compared with previous years, 2012's Russell rebalancing looks to be relatively minor in scope. In 2010, for instance, Berkshire Hathaway (NYSE: BRK-B  ) got added after its share-split made the company eligible for the Russell 1000 Index. That caused a big impact, as the company made up more than 1% of the index's value. Similarly, Sirius XM Radio (Nasdaq: SIRI  ) got a lot of volume when it was restored to the Russell 1000 after getting taken out of the index in 2009 because of its huge share-price swoon during the financial crisis.

But this year, an estimate from Credit Suisse suggests that just 1.5% of the value of the Russell 1000 will be affected by additions and deletions, which is the smallest such percentage in eight years. Still, given that about $3.9 trillion tracks various global Russell indexes, there's plenty of money at stake.

Getting a good deal?
The good news for Russell index investors is that at least for now, funds have an opportunity to buy the estimated 13.5 million shares they'll need at a much cheaper price than IPO participants paid. In the past, excitement about IPOs often led to index funds having to pay premium prices for shares -- only to watch them fall once index-based demand fell off.

But the big question for Facebook investors is what will happen when other indexes get around to adding the stock. The Nasdaq 100 changed its rules to cut the period a company has to trade on public markets from two years to just three months, potentially making Facebook eligible to join the index later this year. The S&P 500, meanwhile, has a more fluid set of guidelines governing additions, but even with Facebook's decline, its market cap is still more than high enough to justify inclusion at its earliest opportunity. All the buying pressure from those other index funds and ETFs could push Facebook's price higher -- at least in the short run.

The downside of index funds
Unfortunately, there's not much you can do to avoid having Facebook in your index funds, short of boycotting the products entirely. Given how useful the products are for low-maintenance, cheap investing, begrudging Facebook its place among highly valued companies probably isn't worth the hassle of finding other ways to replace index funds in your portfolios.

All the buzz around Facebook doesn't change the challenge the social-media giant will face in producing revenue from its millions of members. We've created a new report, "Forget Facebook -- Here's the Tech IPO You Should Be Buying," which details a much better social-media stock with a longer runway for growth than Facebook. The report won't be available forever, so click here to get access today -- it's totally free.

Fool contributor Dan Caplinger grudgingly accepts that he'll soon own Facebook shares indirectly. He owns shares of Berkshire Hathaway. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of Berkshire Hathaway and Facebook. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is something you'll want to own.


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