What's A Sub-Industry?

January 31, 2006

Indexers drill down to the “sub-industry” level, as S&P launches Select Industry Indexes; Plus, new SPDRs.

All of the easy targets are gone, and we've reached the bottom of the well.

That's the only thing I can think of when I hear that Standard and Poor's has rolled out a new suite of indexes, called the S&P Select Industry Indexes, tracking the 139 sub-industry segments of the Global Industry Classification System (GICS).  Sub-industry is the smallest classification bucket in the GICS system; beyond that, you're looking at inidividual companies. It's like Lewis and Clark reaching the Pacific - there's nowhere left to go. 

The index industry has slicing the market into finer and finer segments almost since it was created.  Charles Dow launched the world's first financial index in 1884, tracking the performance of a group of Transportation stocks; this index would come to be known as the "Transportation Index."  Twelve years later, Dow realized that his Transportation Index didn't adequately reflect the U.S. economy, and he went back to the well, adding another index - this time the Dow Jones Industrial Average.  33 years later, his followers launched the Utilities index.

Since then, the number and type of indexes has exploded: Today, there are more than a half dozen major indexing families, all offering their own size and style indexes, international and country products, and even sector bogies.  At times, it seems like there's an index for everything.

But don't tell that to the indexing developers; they seem to think that they're just getting started. In November, Dow Jones Wilshire - that same group that started it all - rolled out 10 new "industry" benchmarks, joining the group of indexers tracking stocks on a sector level.  And then last week, on January 27, S&P did them one better, launching the aforementioned Select Industry Indexes. "Select Industry" is another way of saying "sub-industry": Now, for instance, rather than just "Energy" companies, investors can benchmark themselves against such sub-industry segments as "Oil and Gas Exploration," "Oil and Gas Services," and "Coal and Consumable Fuels."

"Industry-based analysis and investing is increasingly popular and important in today's market," says David Blitzer, managing director and chairman of the Index Committee at Standard & Poor's. "The combination of GICS and Standard & Poor's U.S. indices means investors can accurately target exposure to specific industries."

Investable Products

Make no mistake about it: S&P intends for these benchmarks to support investable products.  They're even willing to sully the purity of their indexes to do it.

Traditionally, one problem with focusing on so narrow a segment is that some sub-industries have very few companies.  Most mutual funds, by law, are not allowed to hold more than five percent of their assets in a single security.

To get around this problems, each one of these new Select Industry indexes has a minimum of 21 stocks (conveniently dipping an equal-weighted portfolio below the 5 percent mark).  If the relevant sub-industry has fewer than 21 liquid stocks, "large stocks from relevant, highly correlated supplementary sub-industries are included."

Which makes one wonder: Is there really demand for sub-industry funds or ETFs?

To some extent, it seems inevitable. Investors and even indexers have been moving in this direction for years.  Actively-managed industry-focused funds targeting hot industries like biotechnology, for instance, have been around forever.  The exchange-traded funds (ETF) revolution accelerated the movement by making it practical to offer narrow industry slices to investors.  Merrill Lynch has been offering it focused HOLDRs products since 1999, giving investors exposure to such narrow industry slices as Wireless or Broadband.  PowerShares pushed the movement forward again in 2004, with its launch of a suite of industry-focused ETFs, using enhanced-index Intellidexes from the American Stock Exchange to track sectors like Oil & Gas Exploration, Networking, and the Food and Beverage Industry. 

But these products have always covered a limited number of industries, and haven't operated at the granular level of the S&P products.  It will be interesting to see if new funds come out focusing on such narrow indexes.

Select Sector ETFs

Meanwhile, S&P and State Street Global Advisors (SSgA) have teamed up to offer funds on the "industry" level. As part of SSgA's aggressive expansion of its ETF franchise, the fund manger will launch three streetTRACKS ETFs in February covering the Select Sector Biotech (XBI), Select Sector Homebuilder (XBH), and Select Sector Semiconductor (XSD) indexes.

This represents the first expansion of the powerful Select Sector franchise beyond the pure sector level. Previously, SSgA offered only nine Select Sector SPDR funds, covering the nine core sectors of the market.  I'd expect to see more of these products in the months and years to come.

From Russia, With Indexes

Rounding out the S&P news, the indexing giant expanded its indexing coverage of the red-hot Russia market, inking an agreement with the Russia Trading System (RTS) to add the flagship RTS Index to the S&P family of indexes. The RTS is a broad market index covering the bulk of the Russian market.  S&P will take over the commercial management of the index, licensing it out to investment managers and the developers of financial products.

"Our clients have expressed a growing interest in products linked to Russian equities," said Robert Shakotko, managing director of Standard & Poor's Index Services. "We are therefore pleased to offer the RTS index, already the recognized brand among Russian indices, as part of S&P's global licensing program."

S&P already offers a suite of Russian indexes, including a large cap index (the S&P/RUX Composite) and sector indexes covering Oil & Gas, Power, Telecommunications and Engineering, based on an existing partnership between S&P and RTS. This agreement clarifies the commercial relationship between the two.

Find your next ETF

Reset All