GICS reclassification to shake up sector ETFs

Jul 18th, 2017 | By | Category: ETF and Index News

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Potential changes to the Global Industry Classification Standard (GICS) being proposed by MSCI and S&P Dow Jones Indices (S&P DJI) could cause a shake-up of the constituents of ETFs tracking the telecom, technology and consumer discretionary sectors. The two indexing firms are currently running a consultation to potentially change the current telecommunications services sector to a new communications services sector.

The implications of the GICS sector review are expected to be announced in November.

The new sector would include three industry groups: the current telecommunications services industry group in its present form, the media industry group moved from its current location in the consumer discretionary sector and renamed media & entertainment, and a newly created industry group named consumer internet & digital services. This newest industry group would carve out some stocks currently in the internet software & services sub-industry in the information technology sector.

The newly renamed media & entertainment industry group could potentially see companies such as Netflix, Disney, Comcast and Time Warner move from consumer discretionary to the newly created communications services sector.

The consumer internet & digital services industry group would be defined as “internet companies facilitating communication using the internet as a tool including companies providing search engines and social media applications such as photo sharing and mobile messaging applications.” The changes could see stocks such as Alphabet, Facebook, eBay, Electronic Arts and Twitter move from the information technology sector to the communications services sector.

The guidance from MSCI and S&P DJI states that the telecommunications services sector is changing as land lines disappear, smart phones become more affordable, and internet connections become increasingly important. Companies in this sector are adapting by diversifying into internet services, cable, media content and other areas by consolidating with other companies.

In addition, the internet software & services sub-industry has become too large and diverse to be useful for analysis or index construction in its current form. It has evolved to include new business models using internet technology to cater to a variety of end users and industries. The internet is now simply a medium for delivery of a company’s products and services.

The GICS guidelines were developed jointly by MSCI and S&P Dow Jones Indices and launched in 1999 with 10 sectors, 23 industry groups, 59 industries and 123 sub-industries. The structure has evolved over time and currently comprises 11 industries, 24 industry groups, 68 industries and 157 sub-industries. The most notable change thus far came in 2016 when real estate was spun out of the financial services sector to become a sector in its own right.

The changes might not affect all sector ETFs equally. The largest information technology sector ETF is the Technology Select Sector SPDR Fund (NYSE Arca: XLK), which has $16.8m in assets under management. However, this fund tracks a combination of the information technology and telecoms sectors already, and as such is unlikely to be affected by the proposed changes.

On the other hand, funds such as the $14.0bn Vanguard Information Technology ETF (VGT) or the $12.3bn Consumer Discretionary Select Sector SPDR Fund (NYSE Arca: XLY) would be forced to divest some of their holdings. VGT currently has 19.9% of its portfolio in internet software & services stocks, including 10.3% in Alphabet and 6.6% in Facebook. XLY currently has a 24.6% weighting towards the media industry and includes potentially affected stocks such as Comcast (7.2%), Walt Disney (5.9%) and Time Warner (3.0%).

There is also the possibility that the changes could have unintended effects on individual stock prices due to the relatively large size of consumer discretionary and information technology funds compared to telecommunications services funds (as they are currently called).

For example, US consumer discretionary ETFs listed in the US currently hold approximately $1.3bn worth of Comcast stock that they might be forced to sell if the proposed changes take effect. This would be offset to some degree by newly-named communications services sector ETFs buying Comcast stock, but the total assets currently invested in US-listed telecoms ETFs is just $2.3bn compared to $17.5bn for US-listed consumer discretionary ETFs.

The consultation runs until 29 September 2017 with any changes expected to be announced in November 2017.

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