GICS Sector Changes Revisited

Six months ago, the investment community was preparing for a major shakeup in sector classifications as the indexes behind popular sector funds were changing and mega-cap companies such as Alphabet, Comcast, Facebook and Netflix were shifting to communications services under a sector revamp of the Global Industry Classification Standard (GICS).

With the benefits of hindsight, we can ascertain how ETF investors responded and whether they better understand what they own.

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As a review, some stocks in the information technology and consumer discretionary sectors were moved in September 2018 to a new communications services sector under the framework mutually used by certain S&P Dow Jones and MSCI indices. (Read “How Sector Changes Impact Portfolios)

As of March 15, 2019, the information technology sector (21% of assets) remained the largest sector in the iShares Core S&P 500 ETF (IVV), and communications services (10%) and consumer discretionary (10%) were the fourth- and fifth-largest. For the iShares MSCI Emerging Markets ETF (EEM), information technology (14%), consumer discretionary (13%) and communication services (12%) were also double-digit weightings.

Big Impact For Sector-Focused ETFs

Yet the impact for sector-focused ETFs tied to these broader indexes was much greater.

Six months ago, the market-cap-weighted Technology Select Sector SPDR Fund (XLK) had a 25% weighting in what today is classified as communication services stocks, including Facebook, Alphabet (Google) and Verizon Communications. The fund looks far different than it did back when interactive media and services companies Facebook and Alphabet were among its largest positions.

Though Microsoft and Apple remain the two largest companies in this $20 billion ETF, Cisco, Intel and Visa impact performance more than they did before.

Sector Weights Prior To GICS Changes

Source: CFRA; as of 9/14/2018

Equally Weighted Contrast

In contrast, the $1.6 billion Invesco S&P 500 Equal Weight Technology ETF (RYT) has changed less in the last six months. This ETF—which holds the same stocks as XLK, but the holdings are equally weighted instead of market-cap-weighted—had just an 8% weighting to communication services stocks.

Like XLK, RYT currently owns no communication services stocks. But the change in holdings made less of a difference to RYT, since other equally weighted holdings like Arista Networks (ANET) and Synopsys (SNPS) were more impactful for this equal-weighted strategy.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

In the six-month period ended March 18, which includes a few trading days before the GICS changes were made, RYT's 1.73% total return was ahead of the 0.14% loss for XLK.

Meanwhile, both ETFs have experienced outflows in the last six months, as investors have added more direct exposure to the current communication services stocks that are found in separate funds like the $5 billion Communication Services Select Sector SPDR Fund (XLC).

CFRA encourages investors to look forward and not just backward when comparing ETFs, and we find these reconstituted sector funds to be a prime example for why this is important. The longer-term records for XLK and RYT are not indicative of future results, since many of the stocks inside in the past can no longer be found in current holdings. Our ETF ratings are driven by a combination of holdings analysis and fund attributes such as expense ratio and trading costs.

Other Shifting Sands

Indeed, at the same time the communication services sector came into existence, many changes also happened for ETFs and funds that track the consumer discretionary sector. Charter Communications, Comcast and Netflix are among the large-cap stocks that shifted to communications services.

Six months ago, the now $12 billion Consumer Discretionary Select Sector SPDR Fund (XLY) held 22% of its assets in stocks currently classified as communication services. Today the market-cap-weighted ETF has a more meaningful stake in hotels, restaurants and leisure companies, including McDonald's (MCD) and Starbucks (SBUX), to provide diversification to an ETF that has a 21% weighting in Amazon.com (AMZN).

Though the $107 million Invesco S&P 500 Equal Weight Consumer Discretionary ETF (RCD) is constructed differently than XLY, with a position in Amazon similar in weight to more moderately sized Capri Holdings, it was greatly impacted by the GICS changes.

Six months ago, RCD held an 18% weighting in stocks currently classified as communication services stocks. While the mega-caps that shifted to communication services tend to get the most attention, RCD also lost moderately sized Discovery and Viacom to the new sector.

Unlike with the technology sector, the market-cap-weighted and equal-weighted consumer discretionary sector funds have performed essentially in line with one another in the past six months.

RCD's 3.14% decline was only fractionally narrower than XLY's 3.31% loss. Here, too, some investors have likely rotated away from these sector ETFs in search of exposure to Netflix and Comcast.

This article was originally published on MarketScope Advisor on March 19, 2019. Visit www.cfraresearch.com for more info.