Investors recently saw a substantial shuffling of the investment deck, to the tune of over $70 billion in exchange-traded funds (ETFs). This reclassification came by way of a change to the old lineup of S&P 500 industry sectors. The sector formerly known as “telecom” has been renamed “communications services.”
This change affects more than just the billions invested in telecom-related ETFs. It impacts how we see and categorize companies, primarily in the communication sector, but also within the larger tech and consumer discretionary spheres.
Of the 23 stocks that now make up the communication services sector, six were former members of information technology, and 16 were in consumer discretionary. Its most well-known members include some components of FAANG — Facebook Inc., Netflix Inc. and Google parent Alphabet Inc.
If you’re an investor who’s concerned about the impact on your portfolio, you’re not alone. I’ve heard from folks that they feel like they went to sleep owning a Mercedes and woke up to a Pinto sitting in the driveway.
But breathe with me. This is not a panic moment. It’s a time to educate yourself on what happened, what it means now, and what it could mean moving forward.
As far back as 1999, there were 10 sectors in The Global Industry Classification Standard (GICS®), developed by Morgan Stanley Capital International (MSCI) and Standard and Poor’s (S&P). Now, there are 11. And these 11 sectors currently represent 24 industry groups, 68 industries, and 157 sub-industries.
If we take a look at the list of firms that have ETFs that will be impacted by this reallocation, it’s the large providers, like State Street, iShares, Vanguard, Invesco, etc. Basically, our list includes any ETF provider who uses the GICS system.
So, if you own ETFs, there is a high likelihood that your investments are involved.
Let’s talk through what’s happening. Here is my list of the top seven things we investors should know and consider.
1. Don’t panic. From everything I can tell, there are no dire consequences here – there should be a minimal-to-no tax impact, and there should be no spin offs. But, if you own any of these ETFs, you should know that the constituents have changed.
2. Yes, there has been a change without you changing. What you own may look the same, but the components of your holdings may have changed in a fairly significant way. For instance, if you owned tech in the form of State Street’s ETF symbol XLK, you still own tech companies, but the mix is different. Many big names have now left the tech index, as we mentioned above. Alphabet (Google), AT&T (Verizon), Activision Blizzard, Electronic Arts, Facebook, and Twitter, are now in the new communications services sector. Comcast, Walt Disney, Netflix, Twenty-First Century Fox, CBD, Omnicom, Viacom, and NewsCorp all got shuffled out of the consumer discretionary sector into communications services, too.
(Interesting sidenote: eBay is moving into the consumer discretionary sector.)
3. What’s the deal with the new sector? The companies in the communications services sector are still available – just in the form of new ETFs. More likely, there will be multiple new ETFs created to reflect this additional sector.
4. There may be a method to the madness. How we communicate in the world today is vastly different than even a decade ago. Communication as a sector is a much better way to define companies. Think about it. AT&T is a communication company with technology, not just a telecom company. The same is true of Netflix, Facebook, Google and the like. If you’re scratching your head on that last one, think about the more than 1.0 billion email accounts that Google provides, and Google Home, and using Google search to find businesses and hitting the call button on our smartphones. See what I mean?
5. The weightings have changed. So how have they made this change a non-taxable or minimal-taxable event? Well, the new ETF created will absorb the newly classified companies, and the ETFs that lost names (like XLK and XLV) will ratchet up the percentages in their existing names. For instance, the new XLK will have a bigger weight in Apple (almost 20%), Microsoft (over 16%), etc. The same thing will happen in the consumer discretionary ETF, with Amazon at about 23% of XLY, Home Depot at over 10%, and McDonald’s at over 5%.
6. What about sector weightings within the overall market? Here’s the list: materials are at 2.5%, REITs are at 2.7%, utilities are at 2.9%, energy is at 6%, consumer staples at 6.8%, industrials at 9.6%, consumer discretionary at 10%, communications services in fourth largest position at 10.6%, financials at 14%, healthcare at 14%, and tech at just over 20%. And that’s about right. There’s technology in everything we do, from railroads to gardens to hospitals, from your car to your kitchen. It makes sense that tech is the largest sector within the S&P 500, as it now greases the wheels for just about everyone else.
7. Bottom line: Should I buy the new sector? The answer depends, of course, on your particular situation. As for me, you all know I’m not a huge fan of Facebook, and that’s the largest holding (along with Google) in XLC. Personally, I would rather own a few telecom names without buying the bundle. So, while I love communication services as a new sector, I’m just not a fan of all the constituents that got shuffled into that deck. My individual choice would be to cherry pick a few rather than own the entire group. At least, for now.