'Investors will go to other indices' after the S&P 500's Tesla snub, market analyst says

The S&P 500's Tesla snub may have a ripple effect.

In a way, the index's choice to exclude Tesla's stock from its holdings is a sign of it "playing defense" in a time when its popularity as a benchmark may be starting to wane, Tom Lydon, the CEO of ETF Trends and ETF Database, told CNBC's "ETF Edge" on Monday.

"A hundred years ago, the Dow Jones Industrials were the benchmark," Lydon said. Now, "many investors and advisors and institutions are looking for indexes like the Nasdaq 100 that are a little bit more modern in nature that will take into account — especially in this new economy — companies that are more forward-thinking."

The S&P's main criteria for inclusion are that the given company must have a market cap of at least $8.2 billion, be headquartered in the United States, have most of its shares in public hands and that the sum of its last four quarters of earnings must be positive.

However, meeting the criteria does not guarantee acceptance into the index. While its committee declined to pave the way for Tesla in its latest reshuffle, it added Etsy, Teradyne and Catalent and removed H&R Block, Coty and Kohl's.

Andrew McOrmond, a managing director at WallachBeth Capital, said the S&P's move may deter investors.

"I think investors will go to other indices," McOrmond said in the same "ETF Edge" interview.

But that doesn't mean the S&P's more "hybrid" approach to a rules-based structure — having some rules, but without automatic inclusion or exclusion — has to change, he said.

"To have a little bit of human intervention, … does that mean that slows them down? Does that mean that people say they're not up to the times?" McOrmond said. "I've seen a lot of rules-based-only investment strategies not do too well in this kind of environment, so, to take a pause and say, 'We're going to look at this and just think it over,' it doesn't mean that Tesla's never going to make it."

McOrmond's best guess as to why Tesla may not have been included this time around was the stock's volatility. The stock suffered its worst single-day loss ever on Tuesday following the S&P's snub, though shares are still up a staggering 337% year to date.

"Let's look at a different stock, just for an example. Let's say Moderna comes out and has the vaccine. That will be a really big company really fast if it's not already," he said. "Then, three months later, God forbid: 'Alright, this one didn't work. Scrap it. AstraZeneca.' And then what does the S&P [say]? 'Oh, sorry we put that in there, we've got to yank it out now.'"

"[My] guess is that they think about the volatility and the rather meteoric rise of these names," McOrmond said.

But the S&P could miss the boat by playing it safe, ETF Trends' Lydon warned.

"Twenty-eight percent [of the index] is represented by FAANG and Microsoft," Lydon said. "I think investors have enjoyed the run up that we've seen in those stocks and what that's meant to the S&P 500 index. Going forward, investors, especially index investors, hope that they'll also have a piece of those future FAANG stocks. When we see instances like Tesla, which is such a big company, not included, that concerns me."

Tesla shares fell roughly 2% on Friday. The S&P 500 sank by about half of 1%.

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