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If we consider ETFs that do sampling in their replication process- as the weight in the index decreases, the stock will contribute less to the tracking error, hence ETFs might as well get rid of it But if we consider full physical replication I don't see how you could be wrong..
I see, you mean a fund that deliberately doesn’t track its index like iShares R2k vs SPDR R2k? Yeah that could have an impact for some small stocks. But most large cap index funds try for perfect replication, and TSLA is one of the biggest stocks in the index!
What I am getting from this is that the “passive funds will need to sell if the price falls” argument does not work. At all.
Only way to make the argument work to me is if you consider imperfect replication, and the more the price falls the less interesting it is to own the stock (I think that's in this context that @alexharfouche1 refers to a convex effect)
I'd say the "imperfect" tracking from those kinds of ETFs is mostly due to market effects during exchanges. If you look at the NAV of those and compare it to the actual index, there's close to no tracking error (and both ETFs seem to use some sort of sampling)pic.twitter.com/0bDtPM7tpv
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