Those investing in passive funds tracking the technology, consumer discretionary or telecoms sectors will be most impacted by upcoming changes to industry classifications, according to the industry experts.
The changes to the GICS (Global Industry Classification Standard) sector classifications – used by index providers such as MSCI and Standard & Poor’s – will see the creation of a new ‘communications services’ sector including tech giants such as Facebook and Netflix.
Indeed, the new sector will a majority of growth stocks that have led markets in recent years and will see some of the mis-matched stocks leave the technology sector.
“Those buying exchange-traded funds [ETFs] will be most impacted, especially if those ETFs track either IT, consumer discretionary or the telecommunication services sectors, as the changes in the underlying holdings will alter the risk profile, growth potential and income generation of these funds,” M&G Investments’ Sarita Kashyap said.
“The impact may also be felt by investors in funds following specific themes, as the changes may alter the funds’ investment strategy.”
Investment & risk specialist Kashyap said the most important thing for investors to remember going forward is that the track records for those sectors most heavily affected by the new reclassification will become “meaningless”.
Upcoming changes to GICS sectors
Source: M&G
As the above chart shows, from 28 September the telecommunications services sector will become the communication services sector.
The Investment Association defines the current telecoms sector as the one containing companies that provide communications services “primarily through a fixed line, cellular or wireless, high bandwidth and/or fibre optic cable network”.
With the changes, GICS aims to include in the new sector not just those businesses providing services, but those facilitating communication and offering related content and information through various media.
As such, the new sector will be a broader group comprising the existing telecommunication companies as well as some companies from the consumer discretionary sector along some from the IT sector.
Some examples of those companies that will now be included in the recalibration of the sector include Comcast, News Corp, Walt Disney, Netflix, Google’s parent Alphabet and Facebook.
According to M&G’s Kashyap, a noteworthy change as a result of the re-design of the sector is that the new set of communication services stocks will lose their main place as the typical ‘bond proxies’.
“They will no longer be the high dividend-paying, value stocks that we have become accustomed to with the current telecoms sector,” she noted.
“The communication services sector will hold a majority of growth stocks from consumer discretionary and information technology and will be more sensitive to the broader equity market and less sensitive to bond yields and interest rates,” Kashyap added.
The sector’s new look is also thought to reflect more fairly the main differences between today’s tech-related companies, which some fund managers believe is needed.
“With how the current sectors are, we look like we have a big bias to the tech sector but there is a massive divergence among the companies in the tech sector,” said Stephen Yiu, manager of Blue Whale Growth fund.
“Tech companies can be classified in three buckets: the semi-conductor, hardware companies such as Intel, the hardware companies – [like] Apple and HP – and those providing software and services –that include the likes of Google, Netflix or Facebook.
“People will put all these stocks together, but they are different, and they do different things; Google is all about advertising and services offered to the consumer. Apple is part of our life, it’s like a fridge or a washing machine: although at home you probably have more than one smartphone or computer,” Yiu explained.
S&P 500 current vs future GICS sector weightings
Source: M&G
The manager of the £68.1m global equities fund said the disparity among these companies makes it necessary to differentiate between stocks, a reason why he welcomes the changes to the telecoms sector.
These, he said, are also going to affect the sector exposure of the fund he runs, reducing the current 43.8 per cent technology weighting to around 30 per cent.
“Many people see our tech exposure and think we are a tech fund, but we aren’t. We like attractive companies with the ability to grow and attractive valuations,” he said.
Wesley Lebeau, a fund manager CPR Asset Management, also believes the new rebalancing of the sector is going to reflect more accurately the reality of the industry and of the fund he oversees.
“I think S&P and MSCI are going to capitalise on the fact that communication now is much broader than it used to be 20 years ago,” he said.
“The sector re-design is going to look much closer to what we already do in the fund with our thematic approach.
“We are looking at some of the stocks with a less messy approach. When we look at the consumer discretionary, IT and telecoms sectors it’s quite difficult to understand why we have eBay classified as a tech company and why companies like Amazon or Netflix are in the consumer discretionary bucket.”
He added: “The changes are going to increase the size of the sector and to unify the telecoms sector, this is going to be more relevant for our approach and our portfolio construction.”
According to GICS, the rapid evolution in the way people communicate, access entertainment content and other information seen over the last few years is one of the reasons motivating the introduction of changes.
This evolution, which is a result of the integration between telecommunications, media, and internet companies, has led companies move further in that direction by consolidating through M&A or by offering bundled 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 body noted.
Performance of sectors vs S&P 500
Source: M&G
This sector division is not the only change in recent years. Prior to 2018’s changes the real estate sector was separated from financials in 2016, noted M&G’s Kashyap.
“Given real estate had done so well before the separation, many expected the real estate to boom as a result of the new classification, which wasn’t the case,” she said.
“Its performance has been lacklustre to say the least since the change, with real estate trailing both its former financials home and the broader S&P 500 and MSCI AC World indices.”
However, with some of last year’s top performers joining the new communications services sectors, Kashyap said expectations on the biggest changes in history to the GICS’s sector structure are high.
“Although you can’t buy past performance and investors should base investment decisions on where markets are likely to be headed in the next 12-18 months, it is definitely one to watch,” she said.