S&P May Disconnect Telecom Sector Index

New York (Reuters) – The S&P 500 Telecommunications Services Sector index may have to hang up on investors, as its creators are considering a restructuring of the once-hot index that has shrunk to just four companies from 14.

After years of consolidation and diversification, today's telecommunications sector would be unrecognizable to investors in the index, which was created in 1996. The index could be three stocks in the third quarter.

"The telecom sector has evolved," said David Blitzer, managing director and chairman of the Index Committee, S&P Dow Jones Indices. "We have been discussing how these changes are impacting the market and expect to consult with investors in the near future."

Back in 1996, AT&T's network carried long-distance calls over the wired network. Verizon Communications—then called Bell Atlantic—made most of its money connecting local calls. Cellphones were a luxury for many, and companies were still figuring out how the internet might be most useful.

Telecom Firms Seek To Diversify

Fast-forward to 2017: Telecom companies are desperately trying to diversify with nontraditional services like TV and home security, as they are now largely dependent on the highly competitive cellphone and internet industry for revenue.

Mergers will further shrink the percentage of revenue from traditional telecommunications, as AT&T—the sector's biggest company—has eyes on media company Time Warner. Regional telecom operator CenturyLink plans to buy Level 3 in the third quarter, a deal that would leave the index with just three companies.

Unlike the other 10 sectors, the S&P 500 telecom segment is so small that there is not a single exchange-traded fund that mirrors it, because a fund holding just a few stocks would fall short of regulatory requirements. Instead, the telecom ETFs that do exist include smaller telecom companies outside the S&P 500 and firms in the technology industry.

The index currently represents just 2% of the S&P's market value, down from 9% at its peak in 1999.

(To view a graphic of “The telecom sector's slow decline,” click on https://reut.rs/2q4056E)

No Clear-Cut Path Forward

But the path to reorganizing the index is not so clear cut for S&P Global and MSCI, which together manage the Global Industry Classification Standard industry taxonomy for indexes. MSCI declined to comment.

Options could include an expansion of the current index. with competitors such as cable operators, or an absorption of telecom companies into another S&P sector, such as consumer discretionary, technology or utilities.

The telecommunications sector's biggest competitors in the S&P 500 are cable operators Comcast and Charter Communications, while media rivals include online services such as Netflix. These companies are in the consumer discretionary index.

But cable companies are regulated differently, and have different service offerings than telecom companies, so they may not be an exact match for a new index.

Consumer Discretionary Could Change

Including AT&T and Verizon in the consumer discretionary index would be a massive change for that sector, as AT&T would be the second-biggest company by market value behind only Amazon, while Verizon would be the fourth-biggest company, just behind Home Depot.

Since slow-growing telecom operators are notable for their high-dividend yields, some investors. including David Haviland, managing partner at Beaumont Capital Management in Needham, Massachusetts, say they should be added to the utilities index.

So far, investors have not been banging on S&P's door looking for an elimination of the sector, according to S&P's Blitzer. But many do question its relevance.

"Four companies does not a sector make," said Haviland, who uses the Technology Select Sector SPDR Fund (XLK) for telecom exposure. "The viability of a three-company sector is highly questionable."