Changes Ahead For 24 Sector ETFs

Last week, S&P Dow Jones Indices and MSCI compiled the full preliminary list of 2,146 companies whose classifications will change Sept. 28, when this year's revisions to the Global Industry Classification Standard (GICS) go into effect.

In short, the GICS change will broaden the existing Telecommunications Services Sector and rename it the Communications Service Sector. The new category will be populated with hundreds of additional companies from the current Consumer Discretionary and Information Technology sectors, including several of the so-called FAANG (Facebook, Apple, Amazon, Netflix and Google) stocks. (For more details about the specific changes, read "Seismic Sector Shift To Shake Up 30 ETFs.")

Already one new ETF—the $195 million Communications Services Select Sector SPDR Fund (XLC)—has been created to reflect the new GICS.

But the revamped classifications will have ripple effects throughout the ETF industry, impacting 24 additional sector ETFs that base their portfolios on the GICS. A combined $72.3 billion is invested in these funds. (See Table 1.)

Source: ETF.com, FactSet data. Data as of July 10, 2018.

Half Of FAANG Reclassified

Two FAANG stocks, Amazon and Apple, won't be changing their current GICS sector classifications. Neither will Microsoft, which is often lumped into the FAANG grouping as well.

However, Facebook, Alphabet (Google's parent company) and Netflix will change categories. Currently classified in Information Technology's soon-to-be-discontinued Internet Software & Services Sub-Industry Group, these three stocks will all move to the new Communications Services Sector instead.

Facebook and Alphabet will be grouped under the Interactive Media & Services Sub-Industry Group, while Netflix will move to the Movies & Entertainment Group. 

Other big-name tech stocks joining Facebook and Alphabet in the Interactive Media & Services Sub-Industry Group include Tencent, Baidu, Weibo and Twitter.

Other streaming services moving to the Movies & Entertainment Group with Netflix include Pandora Media, Spotify and J-Stream.
 
E-Commerce Companies Join Amazon

Some tech-centric companies, however, won't be moving to the Communications Services Sector but rather to Consumer Discretionary, where they'll fall under the Internet & Direct Marketing Retail Sub-Industry Group—a.k.a, the same category as Amazon.

This grouping will now include all e-commerce companies and online marketplaces, regardless of whether they hold physical inventory. Impacted stocks include Alibaba, Shutterstock, GrubHub and eBay.

The list of impacted stocks will be revised twice more before going into effect, at the beginning of August and at the beginning of September.

What Are GICS?

GICS is the joint brainchild of MSCI and S&P Dow Jones Indices, who established the sector benchmarking standard in 1999 to help organize thousands of investible companies from around the world. (The GICS aren't to be confused with the Industrial Classification Benchmark (ICB), the classification scheme that FTSE and many legacy Dow Jones Indexes follow.)

Not every tech ETF uses the GICS system, and not every GICS-based ETF will be impacted by the revisions. For example, the line-up of many telecom ETFs remain unchanged, including the SPDR S&P Telecom ETF (XTL) and iShares Global Telecom ETF (IXP). Semiconductor ETFs, like the iShares PHLX Semiconductor ETF (SOXX), are also unaffected.

However, several ETFs from the four largest issuers—Vanguard, BlackRock, State Street Global Advisors and Invesco—rely on GICS classifications and will therefore be impacted.

Every year, S&P Dow Jones Indices and MSCI review the GICS, though not every annual review results in sweeping revisions like this one. Before this year, the most recent significant revision to the GICS was in 2015, when the Real Estate sector was broken out of its previous home, Financials.

Notably, in response State Street Global Advisors introduced the Financial Services Select Sector SPDR Fund (XLFS) and the Real Estate Select Sector SPDR Fund (XLRE), while also maintaining the broader Financial Select Sector SPDR Fund (XLF). After one year, XLFS closed, as it was deemed redundant after the better-established XLF had dropped its real estate holdings.

How State Street, Vanguard Will Adapt

It is unclear whether State Street plans a similar approach with their five sector ETFs impacted by these GICS changes, or whether they plan to switch them instead to to transitionary indexes before the GICS changes take effect.

Either way, the reclassifications will mean big changes to State Street's tech and consumer discretionary ETFs, two of which also happen to be the largest funds in their segment.

Of the 76 stocks in the $21.8 billion Technology Select Sector SPDR Fund (XLK), 21% will be changing their classification, including Facebook, Alphabet, Activision Blizzard, Electronic Arts, eBay and Twitter.

Meanwhile, in the $13.8 billion Consumer Discretionary Select Sector SPDR Fund (XLY), 18% of holdings are impacted, including Netflix, TripAdvisor, Comcast, Twenty-First Century Fox and Charter Communications.

Vanguard

Vanguard, on the other hand, has already begun swapping the indexes underpinning its three impacted ETFs with transitionary benchmarks designed to smooth the ride for investors.

Among those that have already transitioned are the $20.65 billion Vanguard Information Technology ETF (VGT), the second-largest tech fund; and the Vanguard Consumer Discretionary ETF (VCR), the second-largest consumer discretionary fund.

New classifications are on the way for 15% of the companies in the current line-up of VGT, and 12% of the companies in VCR.
When the new GICS goes into effect, Vanguard's ETFs will switch their benchmarks again.

Contact Lara Crigger at [email protected]