What are the implications of the VW rocket for index and ETF investors? Last week's spectacular price action in Volkswagen shares was another event for the history books, in a year which is setting records in so many ways. But the events of the week have wider implications than the multibillion losses reportedly incurred by some hedge fund managers. The index compilers, notably those responsible for the German DAX, have been forced into drastic action, and ETF investors may also have to review their opinion of some of the benchmark equity indices.

First, a brief recap of what occurred, and the events in pictures.

Porsche had been increasing its stake in Volkswagen shares all year, intent on taking over its fellow-German carmaker. At the same time, many hedge funds noticed that the value of Porsche's stake in VW was greater than the enterprise value of Porsche itself, causing many to enter the same trade - long Porsche shares, short VW. This trade went catastrophically wrong for the fund managers when, last Sunday (October 26), Porsche announced that it had increased its stake in VW to 42.6%, and had entered into a series of cash-settled options trades with investment banks to acquire a further 31.5%, taking its effective holding to 74.1%. With another 20% of VW owned by Lower Saxony, and a further estimated 6% held by index-tracking funds, this left effectively no VW shares in the market to cover a collective short position of around 13% of VW's value.

The result was described by one observer as the "greatest short squeeze I have ever seen", and estimates of the collective losses suffered by hedge funds from the resulting price spike reach 30 billion Euros. VW shares more than quadrupled in two days, briefly propelling the company to the largest in the world by market capitalization. See the chart below for the closing prices of Volkswagen shares over the last two weeks of October. Intraday, on 28 October, the share price hit 1005 Euros, before subsiding to 499 Euros by week-end.

The ETFs most affected by this dramatic price action were those tracking the DJ Stoxx 600 Automobiles and Parts Sector (there are three, managed by iShares, Lyxor and ComStage, the Commerzbank subsidiary). I estimate that by Tuesday's peak VW shares grew to a weighting of around 64% of the auto sector index. More on this below, but here's the price chart of the iShares DJ Stoxx Automobiles and Parts ETF over the same period. The fund's price increased by more than 125% over two trading days, before falling back by week-end.

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