How Sector Changes Impact Portfolios

September 25, 2018

On Friday, Sept. 28, the new GICS sector reclassifications, upon which S&P and MSCI base hundreds of indices, will finally be complete.

ETF.com has covered the impending changes extensively (read: "Changes Ahead For 24 Sector ETFs"). In short, the telecommunication services sector will expand and be renamed the communication services sector, into which will move Facebook (FB) and Alphabet (GOOGL), along with thousands of other companies currently in the information technology sector. Meanwhile, online marketplaces like eBay and Alibaba, previously classified as information technology, will move to consumer discretionary, joining Amazon (AMZN).

But what do all these changes really mean for investors' portfolios?

"This is one of the largest sector reclassifications investors have ever faced," said Daniel Prince, head of iShares’ U.S. Wealth Advisory Product Consulting at BlackRock. "It's time for investors to re-evaluate what that means for their models going forward."

From Defensive To Cyclical

For starters, the new sector will dramatically change in its sensitivity to the broader economy.

Traditionally, telecommunication services was one of the more defensive sectors in the GICS classification. Like utilities or consumer staples companies, telecom stocks tend to be more insulated from big market swings. Plus, they exhibit inelastic demand: Whether markets go up or down, consumers in the 21st century will always need their cellphones and data plans.

All that's changing with the GICS reclassification. Communication services will instead heavily skew toward tech stocks over telecom, meaning the new sector will behave far more cyclically than its predecessor.

That matters because defensive sectors, which post low earnings growth but strong dividends, are often an excellent source of regular income for investors who need it. Meanwhile, cyclical sectors post higher earnings growth and weaker dividends—and are much more connected to market volatility.

Investors who need that income therefore shouldn't sit on the sidelines for the change, says Prince.

How Popular Indexes Will Change

As a result of the GICS revisions, several popular S&P and MSCI indexes—as well as the ETFs based on them—will shift in their sector compositions.

For example, the S&P 500 Index, the basis for the popular SPDR S&P 500 ETF Trust (SPY), the iShares Core S&P 500 ETF (IVV) and the Vanguard S&P 500 Index ETF (VOO), will revise from a 2% sector weight in telecommunication services up to an 11% weight in communication services. Meanwhile, the weight comprised by information technology and consumer discretionary in that index will decrease by 6% and 3%, respectively:

 

Sources: MSCI, iShares; "GICS Reclassification Changes: Implications For ETF Investors" August 2018

 

In the MSCI All Country World Index (ACWI), upon which the iShares MSCI ACWI ETF (ACWI) is based, financials will become the largest sector post-GICS change, instead of information technology. Communication services, meanwhile, will comprise 9%, up from 3% for telecommunication services.

The most dramatic shift, however, comes in the MSCI Emerging Market (EM) Index, the benchmark for the iShares MSCI Emerging Markets ETF (EEM). Information technology will no longer be the largest sector for this index either; post-changes, it will be equal in weight to communication services (15%). In addition, communication services significantly increases in weighting from 4% for telecommunication services:

 

Sources: MSCI, iShares; "GICS Reclassification Changes: Implications For ETF Investors" August 2018  

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