Key Points
The Global Industry Classification Standard (GICS®) will be revamping its shrunken Telecommunication Services sector (now just 1.9%* of the S&P 500 Index) into a hot, newly renamed Communication Services sector. This sector will absorb many growth stocks from the Information Technology sector, including tech titans Facebook and Google’s parent Alphabet, as well as the entire Media industry. Altogether, when the dust settles after the close on this September 28th, we expect the Communication Services sector will hold three of the so-called FAANG stocks (Facebook, Netflix, and Google) and will jump up to about 10%** of the S&P 500—roughly a five-fold increase in weight.
For investors who passively track broad-market capitalization-weighted benchmarks (as many of Aperio’s clients do), we believe their portfolios won’t be meaningfully impacted, because the security weights in their benchmarks won’t change. Meanwhile, investors who actively allocate to GICS-based sectors via exchange-traded funds (ETFs) or other vehicles may wish to reassess their overall investment allocations given the changing risk-and-return profiles of all the sectors impacted by these changes.
Communication Services Sector Gets Big
Today, the number of Telecommunication Services stocks in the S&P 500 has declined to just three (AT&T, Verizon, and CenturyLink) due to decades of industry consolidation and competition from the cable and satellite firms, as well as the evolving landscape of how consumers use the Internet to communicate. We project that 19 companies will be added to the new Communication Services sector in the S&P 500 (see Figure 1), bringing its total to 22.
Figure 1: Twenty companies in the S&P 500 today (shown below with their existing sectors) will be changing sectors. All will move to the Communication Services sector, except eBay, which will move to the Consumer Discretionary sector.
We anticipate these additions to the Communication Services sector will move it from being the smallest sector in the S&P 500 to the fourth largest. Approximately half of the weight increase is expected to come from Facebook and Google as they become part of a hot new industry, Interactive Media & Services (see Figure 2).
Figure 2: The Communication Services sector’s structure will have 10 sub-industries that roll up into five industries—stocks in the S&P 500 are shown below for each sub-industry:
GICS: What & Why
GICS was jointly developed in 1999 by two index powerhouses, S&P and MSCI, to replace the outdated industry classification systems that each had previously been using (neither had a Technology sector). Many index and market data providers at the time (and some still today) had developed their own unique industry classification systems, leading to conflicting classification for many stocks (is MasterCard a tech firm, financials firm, or commercial services firm? Depends on your system). GICS was the first to be jointly developed (FTSE and Dow Jones went on to jointly create their Industry Classification Benchmark). Also unique to GICS at the time was its four-tiered structure with sub-industries rolling up into industries, which roll up into industry groups, which roll up into 11 sectors today.
Every few years, the GICS team reaches out to the investment community (a “consultation”) to assess whether any part of its structure should be updated to reflect market changes. For example, two years ago, the GICS team created a new Real Estate sector. This time around, many tech and all media names will move into the Communication Services sector. Across the global all-cap market, more than 3,600 stocks (many of them small) will have a new classification.
Fun with FAANGs
FAANG is arguably a silly Wall Street acronym (which are all too common—remember BRICs?) for five large, popular tech stocks that have performed well: specifically, Facebook, Amazon, Apple, Netflix, and Google. Interesting that Apple wasn’t included in the original four-company FANG (I suppose no one liked GNAF). Also interesting that Google changed its name to Alphabet, but the acronym FAANA (or including now hot Microsoft to form FANAMA) just doesn’t have the same bite.
The Communication Services sector will have three FAANGs, taking a slice out of the Information Technology sector, which will decrease from having three FAANGs to just Apple (the fifth FAANG, Amazon, will continue to be in the Consumer Discretionary sector).
Risk Management
Sector and industry exposures in portfolios are well-known sources of risk, and in order for portfolio risk management to understand these risks, contemporary classification systems are needed to reflect our ever-changing economy. Yet, there may be those investors who will react slowly and continue to think of stocks the way they used to be classified. Will they be mismanaging risk?
At Aperio, we utilize equity risk models that are updated daily for our portfolio construction and risk management processes. Thus, as stocks, industries, and sectors evolve, we seamlessly integrate these changes into our investment process.
Impact on Aperio Strategies
We do not envision any meaningful impact from these GICS changes on our clients’ portfolios. However, there may be a few minor effects for some factor-tilted or ESG/SRI portfolios.
Because our factor-tilted strategies use “guardrails” on sectors to avoid concentration risk, some portfolios may initially exceed a guardrail with the classification changes. Aperio intends to bring any of these portfolios back in line tax-efficiently when these portfolios are next rebalanced.
For ESG/SRI portfolios, our SRI team is reaching out to any client where we believe any of their industry or ticker exclusions may be worth revisiting given the classification changes. Clients who would like to initiate such a conversation are of course welcome to reach out to us.
To conclude: for clients with Aperio strategies, no action is needed.
Send questions or comments to blog@aperiogroup.com.
