Understanding S&P’s GICS® Sector Realignment
S&P Dow Jones Indices and MSCI are making major changes to the Global Industry Classification Standards (GICS®) structure effective the close of business September 21. The Telecommunication Services sector will be expanded to include selected companies from the Information Technology and Consumer Discretionary sectors and will be renamed Communication Services.
|Company||Ticker(s)||New Sector||Old Sector|
|Alphabet||GOOG/GOOGL||Communication Services||Information Technology|
|FB||Communication Services||Information Technology|
|Netflix||NFLX||Communication Services||Consumer Discretionary|
|Walt Disney||DIS||Communication Services||Consumer Discretionary|
Technology is constantly changing. As an example, many have shifted way from landlines to cellphones and IP phones. Even the way people communicate is changing. Whether it be texting or other apps, older technologies have to change and adapt. This allows for disruptive companies to emerge that offer new ways to connect and interact. The result is a technology sector that contains companies that simply leverage technology to deliver many different services that are not related to a more traditional technology company. To fix this, a realignment of the technology and telecommunications sectors is necessary.
As we see it, there are two key drivers behind the reclassification and changing the name from Telecommunications to Communications Services. First, the Telecommunications Sector was down to just three companies: Verizon (VZ), Century Link (CTL), and AT&T (T) making it somewhat irrelevant as a standalone sector. Secondly, the reclassification aligns companies with the sector that best represents their business model and provides a relevant peer group. For example, Alphabet (GOOGL) and Facebook (FB) generate a significant amount of revenue from advertising, very different from longstanding tech giants, such as Intel and Cisco. The realignment also reduces the impact the Information Technology sector will have on the S&P 500 lowering its weight from 26% to 20% of the total index.
We think it makes sense, but it won’t be perfect. The sector will be concentrated, with Alphabet and Facebook having a combined weight of 47% in the new sector. But even with its shortfalls, we still think its a step in the right direction.
How does it impact GWS?
We are always appreciative when opportunities to increase our potential sources of return and risk, so the new Communication Services Select Sector ETF (XLC) is a welcome addition. Because our investment process is quantitative, every additional data point enhances our ability to precisely measure risk of each asset in the portfolio and more efficiently optimize for the current risk environment.
To illustrate this point, let’s use Alphabet as an example. Currently Alphabet represents approximately 10% of the Information Technology sector and therefore has a meaningful impact on the risk characteristics of the sector. This is important because the risk characteristics between Alphabet and “true” technology companies will likely be very different. Alphabet’s metrics may mask what’s really happening in the technology sector as a whole. This is because Alphabet’s growth and profitability are impacted by different economic drivers than many of the companies in the sector. By realigning the sectors, we now have a more meaningful data point consisting of closely aligned peer groups that helps us increase our probability of success. Overall this is a positive change for GWS and will enhance our ability to continue delivering the results Advisors and their clients expect.
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