Seismic Sector Shift To Shake Up 30 ETFs

On Nov. 15, S&P Dow Jones Indices and MSCI announced a dramatic change to its Global Industry Classification Standard (GICS), which underpins the indexes backing hundreds of ETFs.

The changes, which go into effect next year, will reorganize several high-profile technology stocks and realign sector definitions such that the so-called FANG (Facebook, Amazon, Netflix, Google) stocks would likely move into a single sector.

The revisions, announced as part of their annual review of the GICS, will involve renaming the “telecommunication services sector” to the “communications services sector” and broadening its scope considerably.

The renamed sector will still include telecom companies, but now it will also include internet media companies, mobile gaming app makers, online streaming services, search engines, social media platforms and more.

The ETF Impact

As much as $62 billion in ETF assets could be impacted by the change.

No specific stock reclassifications have been announced yet, but the changes could affect the lineup of at least 30 sector funds, including those from Vanguard, iShares, State Street, Fidelity, Guggenheim and PowerShares. A list of ETFs that could be impacted is below:

New Constituents For VOX, FCOM, XTL

The GICS methodology is reviewed annually to ensure the sector framework continues to reflect the reality of the equity markets. The last time the GICS was reviewed, S&P and MSCI broke out a new real estate sector from the existing financials sector. With it came at least one new ETF, the Real Estate Select Sector SPDR Fund (XLRE) (see: "Growing Pains For New Real Estate Sector").

This year's revision, however, has the potential to be much more impactful.

For starters, the new sector will split into two industry groups: telecommunication services, and media and entertainment.

The telecommunications services group will continue to provide exposure to providers of telecom and related services, but now it will also include internet service providers. That means telecom ETFs like the $1.2 billion Vanguard Telecommunications Services ETF (VOX), the $370 million iShares Global Telecom ETF (IXP), the $112 million Fidelity MSCI Telecommunication Services Index ETF (FCOM) and the $46 million SPDR S&P Telecom ETF (XTL) will likely welcome new constituents to their portfolios, such as AT&T, CBS, Comcast or Verizon Communications.

Netflix Joins The New Sector

The media and entertainment industry group, meanwhile, will yank the erstwhile media industry group from the consumer discretionary sector and put it into the new communications services sector, breaking up its constituents into three new industry groups: media, entertainment, and interactive media and services.

The media industry group will contain advertising, broadcasting, cable and satellite, and publishing companies, while the entertainment industry group will focus on entertainment products and services providers, as well as online entertainment streaming companies. Interactive home entertainment content, such as games or mobile gaming apps, will fall into the entertainment group as well.

Notably, that change would almost certainly move Netflix from Consumer Discretionary into the new Communications Services sector. Netflix is a top 10 holding in consumer discretionary ETFs like the $11.9 billion Consumer Discretionary Select Sector SPDR Fund (XLY), the $2.2 billion Vanguard Consumer Discretionary ETF (VCR) and the $298 million Fidelity MSCI Consumer Discretionary ETF (FDIS), all of which follow the GICS standard.

One-Stop Shop For FANG Stocks

The final category in the media and entertainment industry group would be the interactive media and services industry group, which will rope in companies that create and distribute content and information through proprietary platforms, and whose revenues are derived mostly through pay-per-click ads. These include search engines, social media and networking platforms, online classifieds and online review companies.

Pulling search engines and social media platforms into the new sector will almost certainly reclassify Alphabet (Google's parent company), Apple and Facebook, all of which are currently classified as information technology, under its internet software and services sub-industry group.

In turn, that will likely substantially rejigger the lineup of funds like the $16.6 billion Vanguard Information Technology ETF (VGT), the $1.5 billion Guggenheim S&P 500 Equal Weight Information Technology ETF (RYT) and the $1.3 billion Fidelity MSCI Information Technology Index ETF (FTEC). Alphabet, Apple and Facebook alone comprise 31% of both VGT and FTECs' portfolios. (However, these three companies make up much less of equal-weighted RYT's portfolio—just 4.3%.)

Under the new rules, the FANG stocks will very likely all reside under one sector classification for the first time. If so, they would almost certainly become the engine of growth for the new communications services sector, especially considering that technology stocks, led by these four stocks and Microsoft, accounted for 75% of the S&P 500 Index's gains in October (see: "4 Horsemen of Stock ETFs").

Online Marketplaces Switch Sectors

One thing is for certain: Facebook, Apple and Google will all be reclassified, since their former home, the internet software and services sub-industry group, is being discontinued.

Instead, a new sub-industry group will be created in information technology, under its IT services industry, called internet services and infrastructure. That will cover companies providing services and infrastructure for the internet industry, including data centers, cloud networking and storage infrastructure and web hosting services. This may impact the $4 million SPDR S&P Technology Hardware ETF (XTH), which includes data storage companies like Seagate and NetApp.

Furthermore, the internet and direct marketing retail sub-industry group, which exists under the consumer discretionary sector, will be updated to include online marketplaces and e-commerce companies, regardless of whether they hold inventory.

That particular change likely won't impact Amazon, Priceline or Expedia, all of which are already classified under the internet and direct marketing retail sub-industry group. But it could impact companies like eBay or Cars.com, both of which currently reside in the vanishing internet software and services category.

The full list of companies affected by the sector changes has not yet been announced. A list of select large-caps affected will announced in January 2018, while the full list of stocks affected will be released no later than August.

'Time To Acknowledge' Tech's Evolution

The motivation behind the GICS revisions, said S&P and MSCI in a joint statement, was the rapid evolution and blending of internet, media and telecom companies.

"The internet began as a technological approach to sharing information; it has become the way many businesses operate," said David Blitzer, chairman of the Index Committee at S&P Dow Jones Indices, said in the press release.

"Cable companies are combining with telecom companies, creating their own media content and delivering it to consumers. The lines among media, communications and content are blurred. It is time to acknowledge this convergence and the overlapping services these companies provide," he added.

One big question that remains is if and how technology conglomerates such as Amazon or Apple will be reclassified. Consider Amazon. Its Amazon Web Services division contributed the majority of the company's Q3 2017 growth; should Amazon then be lumped into the new internet services and infrastructure sub-industry group? Or does its Amazon Video Prime streaming service, the second-most-popular such service in the market, mean the company should go in the entertainment industry group instead? Or, as the world's largest e-tailer, does it stay where it is in internet and direct marketing retail?

Don't Be Fooled By Track Record

Though the changes will be sweeping, they're unlikely to change a 30,000 foot view of the technology sector, says Todd Rosenbluth, senior director of ETF and mutual fund research for CFRA: "Technology index ETFs and mutual funds should continue to own Apple and Microsoft and other large-cap stocks."

Still, investors looking to access certain tech stocks and/or subsectors through ETFs will need to revisit their allocations in the coming months.

"The pending changes highlight the importance of investors understanding what's inside ETFs and mutual funds," added Rosenbluth.

Even though the indexes underpinning their sector funds are changing, "these products will continue to showcase an unchanged track record. For those shareholders and potential ones that focus solely on a past performance, they’ll miss the big picture and fail to understand what will drive these products going forward,” he noted.

Therefore, instead of looking to the past for answers, "understanding what's inside a fund can help [investors] to understand its future prospects," Rosenbluth said.

Contact Lara Crigger at [email protected]