Equity Sectors Makeover: Prepare for Change
On September 28, S&P Dow Jones and MSCI, co-developers of the Global Industry Classification Standard (GICS), will implement one of the largest changes in the history of the GICS structure. The Telecommunication Services Sector will be renamed and broadened as Communication Services.

We want to make clients aware of this imminent change because we know, through the work of our Portfolio Consulting Group, that advisors’ investment models often employ at least one equity sector-specific strategy. The team has performed over 600 model portfolio reviews, looking beyond fund-level data and examining underlying holdings to help clients better understand true exposures under different lenses. Nearly half of all models the team has reviewed have sector-focused equity strategies.

Why S&P Dow Jones and MSCI Are Changing the Sector Classification

As stated by the index providers, the change is intended to address the convergence between telecom and media companies” by including “the existing telecommunication companies, as well as companies selected from the Consumer Discretionary Sector currently classified under the Media Industry Group and the Internet & Direct Marketing Retail Sub-Industry, along with select companies currently classified in the Information Technology Sector.”

Taking note of the change will be key for advisers. In our reviews, we have found that 12% of investment models have a strategy dedicated to one of the impacted sectors.

The Characteristics of Impacted Sectors Will Change

Household names such as Facebook, Alphabet (parent of Google), and Netflix will now be in the same Communications Services Sector as AT&T, Verizon, and T-Mobile. Essentially, the overhauled sector will look significantly different than its predecessor— Telecommunication Services. Previously, this was the highest-yielding sector in the S&P 500 Index, at 5.7%, as well as in the MSCI All Country World Index (ACWI) at 4.6% (as of August 31, 2018, for both yields). After the change is implemented, the new Communication Services Sector will have yields, for both indices, between 1% and 2%. As Exhibit 1 illustrates, given that decline in the sector’s yield, the Communication Services Sector will not be able to serve as a proxy for bonds in the way the old Telecom Sector did.

Exhibit 1: A Bond Proxy Sector No More

                              Dividend Yield
 S&P 500 Index1MSCI All Country World Index2
Telecommunication Services (Old)5.6%4.6%
Communication Services (New)1.4%1.8%

Source: FactSet as of August 31, 2018.

All the sectors affected by the GICS update will also see significant changes in their style tilts:

  • The defensive nature of the legacy Telecom Sector will be upended, as it will be transformed from 100% value-oriented to predominately growth-oriented.
  • Consumer Discretionary will see its exposure to growth names increase.
  • Information Technology’s growth tilt will diminish as the result of new, larger weightings to value and blend stocks within that sector.

Exhibit 2: Sector Style Tilts Are Changing

Industry Weights Will Change

Finally, the change will make what was previously the smallest sector of both the S&P 500 and MSCI ACWI indices into one that constitutes around 10% and 9%, respectively, of each index. At the same time, the weights of the Consumer Discretionary and Information Technology Sectors will decrease.

Exhibit 3: Tech Sheds Weight While Communication Services Beefs Up

Traditionally treated as a high-yielding defensive sector in portfolio construction, the new Communications Services Sector will exhibit significantly different characteristics with its inclusion of internet retail, media, and technology names. With the impending sector classification change, ETF providers are preparing in different ways. Some have already adjusted their product lines to reflect the new classifications and others have created temporary benchmarks to smooth the transition.

Plan Accordingly

We would advise our clients to keep this upcoming change in mind when considering equity asset allocation, specifically the impact it may have on equity sector over- and underweights. If you would like to explore how your investment model may be impacted, please reach out to partner with us. Our Portfolio Consulting service can help you discover any unintended risks or potential opportunities in relation to the objectives of your model.

The Portfolio Consulting Group

The Portfolio Consulting Group offers multi-faceted, unbiased reviews of advisor models, highlighting asset allocation, risk analysis, and manager selection. This analysis helps advisors better understand and improve model characteristics, such as diversification, investment style, and overall exposure.

  1. ^The S&P 500® Index is a capitalization-weighted index of 500 stocks intended to be a representative sample of leading companies in leading industries within the U.S. economy. Index includes reinvestment of dividends but does not include fees, expenses, or taxes. The index is unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict performance of any fund. Past performance does not guarantee future results.
  2. ^The MSCI® All Country World Index (ACWI) is designed to measure the equity market performance of developed and emerging markets. The index is unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict performance of any fund. Past performance does not guarantee future results.