Ch-ch-changes: sector shake up!

Come September, the biggest change to the sector structure in the Global Industry Classification Standard (GICS) history will take place, with more than 8% of the S&P 500 index market cap being re-classified into the new Communication Services sector. Under the changes, the existing Telecommunication Services sector will be combined with certain companies from the Consumer Discretionary and Information Technology sectors in the S&P Dow Jones and MSCI indices. This is to better reflect modern communication activities and will include companies that facilitate communication and offer related content and information through various types of media such as Comcast, News Corp, Walt Disney, Netflix, Alphabet (Google’s parent) and Facebook.

This will likely be a welcome change for the unloved telecoms sector, which is not what it used to be compared to a couple of decades ago and now has the smallest sector weighting in the S&P 500 and MSCI AC World indices respectively. The sector is driven by fierce competition, with new ways of communicating continually entering the market and consistent and expensive upgrade cycles reducing its traditional defensive appeal. Debt loads on telecoms companies have also been climbing over recent years with rising consumer demand for wireless services increasing costs for providers due to the need for large equipment upgrades. As a result, the telecoms sector has the highest debt-to-equity ratio of any non-financial sector in the S&P 500!

One notable change with the new set of Communication Services stocks is that they will no longer be the typical ‘bond proxy’, high dividend paying, value stocks that we have become accustomed to with the current Telecommunication Services sector. 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. There will be a new look and feel about the sector. Not only that, but investors might not be able to gain exposure to certain tech companies as easily. The Consumer Discretionary sector will gain some of this year’s high-flying tech names, while losing other ones like Netflix that have helped bolster its performance.

This is not the first time that there have been sector divisions. In 2016 the Real Estate sector separated from Financials and many expected Real Estate to boom after the change, given it had done so well before the separation. However, 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.

So, what do the changes mean for investors? Well, those that invest in 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. The impact may also be felt by investors in funds following specific themes as the changes may alter the funds’ investment strategy. But what is most important for investors to remember is that the track records for the sectors most heavily affected by the GICS reclassifications will become meaningless.

With some of the star performers of last year joining the Communication Services sector, expectations will be high. But 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, not where they were 12-18 months ago. It is definitely one to watch…

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.