THINKING: Perspectives

Everything You Wanted to Know About the 9/28/18 GICS Revisions

GICS Revision: What’s Happening?

On September 28, after the stock market close, S&P Dow Jones will commence the largest ever revision of the Global Industry Classification Standard, better known as GICS, that will have far-reaching implications for portfolio managers. First announced in November 2017 by both S&P Dow Jones and MSCI, the changes will impact about 10% of the S&P 500’s market capitalization, focusing primarily on many high-flying TMT (technology, media and telecom) stocks and their related funds, including ETF’s. MSCI will implement the changes on November 13, 2018 as part of its Semi-Annual Index Review, with an effective date of December 3, 2018.

The indexing firms said the changes are intended to improve the categorization of stocks to reflect the changing nature of the global economy.

Why is this Happening?

Let’s face reality–The VCR is dead. So are the CD, the MP3 player, and the Sony Walkman. And every day more and more people are shopping online and accessing entertainment content from their handheld devices.

Per MSCI’s press release, “The last several years have seen rapid evolution in the way people communicate, access entertainment content and other information. This evolution is a result of the integration between telecommunications, media, and internet companies. Companies have moved further in this direction by consolidating through mergers and acquisitions and many now offer bundled services such as cable, internet services, and telephone services. Some of these companies also create interactive entertainment content and aggregate information that is delivered through multiple platforms such as cable and internet, as well as accessed on cellular phones.”

“The other component to this realignment of sectors,” says Dustin Lewellyn, Chief Investment Officer of Penserra Capital Management, “is that the Information Technology sector has simply become too big. It’s currently 26.4% of the S&P 500 and likely would continue to expand given the scale effects of technology companies. It’s clear the sector has become too large and indicates that the sector’s definition has been painted with too broad of a brush. It’s time for a change.”

How is this Going to Happen?

To the average investor, here are the highlights;

  • Telecommunications Services will be broadened and renamed as “Communications Services”
  • Media Companies will move from Consumer Discretionary to Communication Services
  • Internet service companies will move from Information Technology to Communication Services
  • E-commerce companies will move from Information Technology to Consumer Discretionary.

The specifics, per a joint press release issued in January 2018 by S&P Dow Jones and MSCI, are as follows;

  • The Telecommunication Services Sector is being broadened and renamed as “Communication Services” to include companies that facilitate communication and offer related content and information through various media.
    • The renamed Sector will include the existing telecommunication companies, such as AT&T (T) and Verizon (VZ), as well as companies selected from the Consumer Discretionary Sector currently classified under the Media Industry Group, such as Comcast (CMCSA) and Disney (DIS).
    • It will also include companies from the Internet & Direct Marketing Retail Sub-Industry such as Netflix (NFLX) and TripAdvisor (TRIP), along with select companies currently classified in the Information Technology Sector, including Alphabet (GOOGL) and Facebook (FB)
  • The Internet and Direct Marketing Retail Sub-Industry will be updated to include all online marketplaces for consumer products and services. The Sub-Industry will include e-commerce companies regardless of whether they hold inventory, and include Alibaba Group (BABA) and eBay (EBAY).
  • Companies currently classified in the Internet Software and Services Sub-Industry such as data centers, cloud networking, storage infrastructure, and web hosting services will be moved to a new Sub-Industry called “Internet Services and Infrastructure” under the IT Services Industry. The Sub-Industry will include companies such as Verisign (VRSN) and Shopify (SHOP).
  • Cloud-based software companies currently classified as Internet Software and Services such as Logmein (LOGM) and Nutanix (NTNX) will be reclassified as Application Software.
  • The existing Internet Software and Services Industry and Sub-Industry will be discontinued.

What Does This All Mean?

Investors with exposure to Technology, Consumer Discretionary and Telecom sector ETFs should pay attention to the changes given the potential repercussions for risk, their growth potential, and income generation potential. Yet it’s important to remember that the GICS reclassifications mean next to nothing for the underlying companies themselves, which will continue to execute on their business plans and attempt to maximize shareholder value as they did prior the sector reclassifications.

Investors should also take note of the following;

  • Communication Services will become the S&P 500’s fourth largest sector, representing almost 12% of the index.
  • None of the so-called FAANG high-growth stocks – Facebook, Apple, Amazon, Netflix and Google-owner Alphabet – will be classified as technology companies, even though investors widely view them as the leaders of a tech rally that has powered the stock market higher in recent years.
  • Amazon (AMZN) will remain in the Consumer Discretionary Sector.
  • Apple (AAPL) will remain in the Information Technology index. However, with the removal of Alphabet and Facebook, it’s sector weight will increase to 20% from 16%.
  • Microsoft (MSFT) will also remain in the Information Technology index. However, its sector rate will rise to 16% from 12%.
  • According to Instinet, flows resulting from the GICS sector classification changes have done well over the last month (+2.72%) and have outperformed the larger S&P 500 trade.  The contribution to the spread has been evenly split between the names changing sectors (to be sold) and the reinvesting portion of the trade.