New Sector ETF Evolutionary

June 28, 2018

Noel ArchardNoel Archard, global head of SPDR Product at State Street Global Advisors, has been involved in the ETF industry for over a decade, and has just shepherded the issuer through the launch of its 11thSelect Sector SPDR, one that seriously changes the shape of the ETF sector family. Here, he discusses the implications of the addition of the Communication Services Select Sector SPDR (XLC). Would you talk about the investment argument for this new sector, and why it was a necessary change?

Noel Archard: Telecom was such a robust piece of the economy for so long, but it really changed over the years. The companies were not pure plays. They were really looking at different ways to communicate and interact with the end users. And that was on the internet, through landlines. through different wireless technology. They gave a much more expansive view. Having those included as part of telecom, part of information technology, part of consumer discretionary, didn’t quite fit what the modern economy, and even modern society, looks like.

So it’s a nice evolution of sectors to bundle all these together into one more logical holding. How will the change affect the other select sector SPDRs?

Archard: When you think about the telecommunication services sector, 100% of those names go into communications service, and with consumer discretionary, about 24% come out. And then 20% of information technology will come out and go into the new communications services sector. This is as of where we are now, obviously; there could be a little bit of wiggle on those numbers by September.

It’s Verizon, Facebook, Alphabet, Netflix—some pretty common and popular names out there within the sector.

If you think about the evolution from telecom to communications services, telecom’s underlying securities all had 100% value tilt. You look at communication services, and it’s more around 57% growth. You’ve got a much different flavor to the communication services sector, and obviously, that was one of the reasons we wanted to get it out early and let investors review it, take it for a test spin, understand how it will work into their strategic impact, full rotation programs, once the changes are in effect on Sept. 24. How is this change different from the addition of the Real Estate Select Sector SPDR Fund (XLRE) back in 2015?

Archard: XLRE, in some ways, was a little more simplistic. When you do these changes, there’s always a bunch of moving parts. But if you look at the financials sector, real estate was being carved out. So, when we looked at it, it did lend itself to the approach that we took of doing a distribution.

If you held [the Financial Select Sector SPDR Fund] (XLF), your intent was probably to hold—at the end of the change, you probably didn’t want to just give up those securities. So if you were a holder of XLF, we figured out a way to facilitate the change such that you could be a holder of XLRE then, when all the dust settled from the rebalance.

It’s a little less clear when you're looking at telecom basically morphing into communication services. It was a little less clean to take the approach of doing a distribution. Then, we thought the smarter course of action would be to prelaunch XLC ahead of the index change. That way it’s available for our investors to look at and think about how they might position trades from the Technology Select Sector SPDR (XLK) and the Consumer Discretionary Select Sector SPDR (XLY) when the change comes in September.

It also creates a vehicle for investors who might be using some of the other competing sector products to move into, while those changes are going on in their funds, because everyone is handling it slightly differently. We wanted the communications services to be a pure play. We didn’t want to do some type of customized benchmark, to do a “leg in” approach, because that’s harder for the institutions, from our perspective.

We thought this approach satisfied multiple end-clients’ needs to have it out there through the summer, and then be good to go come Sept. 24. Telecom previously was always folded into XLK, the tech fund. Why was that?

Archard: With the Select Sectors, if you think about the construction, it basically divvies up the S&P 500 with no overlap. Telecom never really lent itself to a select sector SPDR construct because of the diversification needs that we had within the fund, unless we pushed down into midcap and small-cap. The clients want the breakdown of the sectors. This is a really nice change for us, because now we’ve got the complete lineup out there. In general, do you see these changes as ahead of the curve, or anticipatory? Or are they kind of catching up with the new reality?

Archard: It’s probably somewhere in between. It definitely reflects the new reality. It was planned with an eye towards, when you think about telecom, where are telecom companies putting their energy into expansion? And then, how do we actually communicate? Literally, as a society, what are the venues that we use, when we want to get in touch with family? It’s just as likely to be on Instagram as it is over text, as it is over a phone call. It’s definitely a new environment, and the sector just reflects the ways that we keep in touch, frankly. Do you think that index methodology has changed fast enough to keep up with the market, given how the evolution of the market seems to have accelerated?

Archard: It’s done at an appropriate pace, because when you think about the dollars that are benchmarked to the big mainstream indexes, you don’t want to be precipitous. We've seen plenty of companies come and go in the blink of an eye. You do want to see a little bit of staying power. You do want to see longer trends. And frankly, there are all sorts of ways, from a product provider perspective, if you want to go down a different road.

And that’s part of what we did when we launched the Kensho sector SPDRs last year. We’ve got this sort of very traditional GICS market-cap-weighted franchise, but there are other ways to look at the economy, and to put things together. We started expanding the horizon in order to have a different sleeve for investors who believe in that. I think the pace of change is actually pretty spot-on.

Contact Heather Bell at [email protected]

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