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S&P, MSCI Industry Sectors prepare for radical revisions in September 2018

Written By | May 8, 2018

WASHINGTON: As if small investors and ETF fans don’t have enough stock market issues to deal with, the familiar current S&P sectors are about to be changed. Big time. Plans for extensive S&P and MSCI sector revisions are nearing final agreement. They are now scheduled to take effect on September 28, 2018. Once implemented, the revisions could cause some temporary heartburn for ETF investors and other stockholders this coming fall.


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A bit of historical background. Standard and Poor (S&P) and MSCI (a combination of Morgan Stanley Capital International and MSCI Barra), put their collective heads together to create something called the Global Industry Classification Standard, aka GICS®.

To oversimplify, under the GICS, the largest U.S.-based stocks and some international stocks were gathered into a number of industry sectors, groups, industries and sub-industries. Among other things, these classifications, particularly sector classifications, provided the investment industry with a whole new set of investing tools.




The investment industry put them to good use almost immediately. In this case, the investment industry mounted an aggressive and explosive ETF creation campaign that continues even today.

Drawing on various indexes of stocks that conformed to the accepted classifications, investment firms created not only broad, new ETFs that tracked MSCI and other industry sectors. They also created more specialized ETFs that used MSCI, S&P and other sector measures categories to track more specialized industry and sub-industry sectors under the GICS rubric. Over the years, the ETF sector continued to grow, adding more and more specialized ETFs along the way.

Today’s wide array of ETFs offers investors a choice of investing in entire sectors rather than in individual stocks. This helps protect investors from putting too much of their money in a promising stock that turns into a loser. Investing in an otherwise healthy sector that contains that stock in its MSCI index can be an excellent tactic. Investors can broaden their portfolios and lessen the risk of investing only in Promising Stock X.

Sector ETFs are not only useful as a measure of a sector’s performance. These ETFs can help lower the volatility of individual portfolios. An added plus: by investing in a given index ETF, individual investors can effectively acquire a broadly-based portfolio that they could not otherwise acquire as individual stocks, given the cost of each individual stock.

For a considerable period of time, the primary S&P and MSCI consisted of 10 investing categories. But some two years ago, both organizations created an eleventh sector. It contained increasingly popular high-dividend REITs (Real Estate Investment Trusts).

All REITs used to be lumped into the “Financial” sector. Due to the new REIT sector, those REITs investing in physical properties moved from the Financial sector to the new REIT sector in 2016. Those REITs primarily involved in lending money to the building industry remained in the Financial Sector. We list the current industry sectors below.

  1. Consumer Discretionary
  2. Consumer Staples
  3. Energy
  4. Financials
  5. Health
  6. Industrials
  7. Materials
  8. Real Estate (primarily REITs)
  9. Technology or Information Technology
  10. Telecom
  11. Utilities

These have all been useful categories over the years. But the 21stcentury has accelerated the rate of change in businesses and industries. That led S&P and MSCI to consider some fairly profound changes in the “content” of each sector. The idea is to better reflect how modern companies – and their stocks – function in our brave new world.

For example, it seems almost silly to have a Telecom sector any more. The S&P Telecom sector is down to just 3 large individual telecom stocks that are contained in the S&P 500 index. That makes Telecom hardly a widely based category any more. And, not surprisingly, not very worthy of ETF inclusion either.

According to our brokerage firm’s report, that’s a big reason why S&P and MSCI have taken a hard look at the tiny Telecom sector.

“Additionally, there have been questions about whether the Information Technology sector was the best place for some of the more social-media-type names to reside—while they are using technology, of course, they are providing more of a communication medium.



“As a result, MSCI and S&P Dow Jones Indices announced late last year that they will broaden the telecom sector and rename it Communication Services, effective after the close of business on September 28, 2018.”

But other major sectors are getting shuffled, too, to help them conform to current rather than past reality.

S&P and MSCI are

“taking this opportunity to move a wide range of companies around. That will create a dramatically different sector landscape.

“We already knew that the Media Industry—including such companies as Comcast, Disney and Time Warner—is moving to the new Communication Services sector from the Consumer Discretionary sector. But we learned in recent statements from S&P and MSCI that the shift will also affect some of the famous FANG (Facebook, Amazon, Netflix and Google/now Alphabet) names.

“The F, N, and G are all on the move with the A standing pat…for now. Facebook and Google/Alphabet are moving to the new Communication Services sector from the Information Technology sector, while Netflix will move to the new group from the Consumer Discretionary sector.

“The Tech sector will also lose companies that are more retail-related, such as Alibaba, eBay and GrubHub, to the Consumer Discretionary group.”

Our brokerage report further notes that

“Facebook and Alphabet, at current market-cap levels, would make up roughly 43% of the new Communication sector—further illustrating in our mind the loss of the defensive label from that group. Additionally, Amazon by itself will make up almost 27% of the revised Consumer Discretionary sector, while the retailing industry will make up 60% of the group, up from roughly 47% now.”

So what do we do about the upcoming changes in S&P and MSCI sectors?

What does this all mean? The simplest answer? Changes percolating through the system in September will significantly alter the holdings in many sector-based ETFs. And not just the broadly based ETFs.

Note an additional change as a result of the first. Investors and advisors who preach the virtues of “balanced portfolios” may have to do some buying and selling this fall. The industry sector changes may require passive portfolios to actively buy and sell this fall to remain balanced.

The change in the current Telecom holdings – soon to become Communications – could be the most interesting. It promises to transform a relatively moribund sector consisting mainly of AT&T (symbol T) and Verizon (VZ) into something quite different. And definitely more volatile and exciting.

Stay tuned.

 

Terry Ponick

Biographical Note: Dateline Award-winning music and theater critic for The Connection Newspapers and the Reston-Fairfax Times, Terry was the music critic for the Washington Times print edition (1994-2010) and online Communities (2010-2014). Since 2014, he has been the Senior Business and Entertainment Editor for Communities Digital News (CDN). A former stockbroker and a writer and editor with many interests, he served as editor under contract from the White House Office of Science and Technology Policy (OSTP) and continues to write on science and business topics. He is a graduate of Georgetown University (BA, MA) and the University of South Carolina where he was awarded a Ph.D. in English and American Literature and co-founded one of the earliest Writing Labs in the country. Twitter: @terryp17