How Sector Changes Impact Portfolios

September 25, 2018

Which ETFs Will Be Impacted?

To be clear, no stocks will enter or exit these indexes because of the GICS reclassifications. The indexes' existing constituents will remain the same; they'll just switch which particular sector bucket they fall into.

Furthermore, if you only invest at the broad market level, rather than the sector level, "this is a nonevent for you," said Prince.

What will change, however, is the composition of ETFs that slice-and-dice these indexes along sector lines. We've previously reported on that list of funds; we reproduce an updated version below:

 

Sector ETFs Impacted By GICS ChangeFund AUM ($M)Segment
Ticker Fund AUM ($M) Segment
XLK Technology Select Sector SPDR Fund 23120 Equity: U.S. Technology
VGT Vanguard Information Technology ETF 22230 Equity: U.S. Technology
XLY Consumer Discretionary Select Sector SPDR Fund 15670 Equity: U.S. Consumer Cyclicals
VCR Vanguard Consumer Discretionary ETF 3190 Equity: U.S. Consumer Cyclicals
IXN iShares Global Tech ETF 2480 Equity: Global Technology
FTEC Fidelity MSCI Information Technology Index ETF 2310 Equity: U.S. Technology
IGV iShares North American Tech-Software ETF 2090 Equity: North America Software
RYT Invesco S&P Equal Weight Technology ETF 1880 Equity: U.S. Technology
IGM iShares North American Tech ETF 1660 Equity: North America Technology
VOX Vanguard Communication Services ETF 1040 Equity: U.S. Telecommunications
XRT SPDR S&P Retail ETF 758 Equity: U.S. Retail
TECL Direxion Daily Technology Bull 3x Shares 749 Leveraged Equity: U.S. Technology
FDIS Fidelity MSCI Consumer Discretionary Index ETF 690 Equity: U.S. Consumer Cyclicals
PSCT Invesco S&P SmallCap Information Technology ETF 450 Equity: U.S. Technology
RXI iShares Global Consumer Discretionary ETF 318 Equity: Global Consumer Cyclicals
XSW SPDR S&P Software & Services ETF 136 Equity: U.S. Software
FCOM Fidelity MSCI Telecommunication Services Index ETF 117 Equity: U.S. Telecommunications
PSCD Invesco S&P SmallCap Consumer Discretionary Portfolio ETF 94 Equity: U.S. Consumer Cyclicals
XWEB SPDR S&P Internet ETF 58 Equity: U.S. Internet
RETL Direxion Daily Retail Bull 3x Shares 41 Leveraged Equity: U.S. Retail
TECS Direxion Daily Technology Bear 3X Shares 30 Inverse Equity: U.S. Technology

Sources: ETF.com, FactSet; data as of Sept. 19, 2018

 

(For more information, read: "Changes Ahead For 24 Sector ETFs.")

In addition to these vanilla market-cap-weighted funds, certain smart-beta ETFs that use the S&P and MSCI indexes as baselines for their strategies will also be impacted, such as the Invesco S&P 500 Equal Weight Consumer Discretionary ETF (RCD).

Plus, at least one new ETF has launched dedicated to the new communication services sector: the Communication Services Select Sector SPDR Fund (XLC). In its three-month life span, the ETF has already accrued $977.5 million in assets under management.

Question Of Timing

To reflect the reclassifications, GICS-based indexes will require rebalancing, the timing of which differs depending on the indexer.

S&P Dow Jones Indices have already rebalanced their relevant indexes, coinciding with a quarterly rebalance on Sept. 24. The only exception is the S&P North American tech sector, which rebalances on Dec. 21. (This index serves as the basis for the iShares North American Tech ETF (IGM), which, according to Prince, will retain Facebook and Alphabet, among others, despite the GICS reclassifications.)

Meanwhile, MSCI will rebalance its indexes as part of its November 2018 semiannual index review, effective Nov. 30.

That means MSCI indexes (and presumably the ETFs based on them) could begin tracking significantly out of step with their underlying GICS classifications throughout the next two months.

Capital Gains On The Way?

Regardless of the timing of a rebalance, it will mean turnover—which could in turn lead to capital gains. However, some ETF issuers have worked hard to avoid capital gains events for their investors, baking the expected changes into their funds slowly.

Vanguard, for example, appears to have used the in-kind creation/redemption process for several weeks this summer, in order to avoid large capital gains distributions from occurring in its two ETFs impacted by the GICS changes: the Vanguard Information Technology ETF (VGT) and the Vanguard Consumer Discretionary ETF (VCR) (read: "Behind Vanguard's Strange 'Heartbeat' Flows").

But there's no guarantee. Investors should remain aware that big rebalances and reconstitutions could lead to an unwelcome tax event come next April.

GICS Vs Non-GICS

One last caveat: Investors should remember that not all sector ETFs are based on GICS classifications. For example, iShares, Invesco and First Trust all offer sector ETFs based on non-GICS benchmarks, including Nasdaq indexes, Dow Jones indexes and self-branded indexes.

After the GICS changes, meaningful differences are likely to emerge in the performances of GICS-based ETFs versus non-GICS based ones, says Prince, due to the varying exposures. He cites the example of the iShares U.S. Technology ETF (IYW), which will retain exposure to Facebook and Alphabet, versus the Technology Select Sector SPDR Fund (XLK), which won't.

"More investors will become aware of the GICS changes once they start to note changes in performance," he added. "Investors will need to know what they own, and be able to tell the difference between two funds that have similar names but very different holdings."

Contact Lara Crigger at [email protected]

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