Prepare now for some key sector changes.
Late last year, S&P Dow Jones Indices and MSCI announced a makeover to the telecommunication services sector. It will be renamed "communication services" and a number of stocks will be reclassified. For example, Facebook (FB , Alphabet (GOOGL , and Netflix (NFLX will join the new communication services sector (the former two from information technology and the latter from consumer discretionary).
A cadre of other stocks will also be reclassified including Twitter (TWTR , Snap, Inc. (SNAP , and Etsy (ETSY (currently in the information technology sector) along with The New York Times (NYT , Walt Disney Co. (DIS , Comcast (CMCSA , and DISH Network (DISH , all classified as consumer discretionary firms.
S&P and MSCI noted that the intent is to broaden the sector to include companies that "facilitate communication and offer related content and information through various media." The firms also announced updates to sub-industry groups within both the new communication services and information technology sectors. As of this writing, the reclassification was targeted for late September 2018.
The revamped sector is estimated to be anywhere between the third- and fifth-largest in the S&P 500 Index
What This Means for Investors
While this change may seem trivial, industry classification plays an important role in the underlying holdings of passively managed sector funds. For investors in actively managed mutual funds (diversified or sector specific), these changes will have very little, if any, impact on mutual fund holdings. Active managers regularly invest outside of benchmarks and may place little weight on sector classification during their research process.
For investors in sector-specific passively managed funds, this could change the underlying investments and possibly the future return expectations for funds investing in the information technology, consumer discretionary, and communications sectors.
For example, as of the end of May (the most recent available portfolio data as of this writing), Facebook and Alphabet shares accounted for about 12% of the Vanguard Information Technology ETF (VGT and for just over one percentage point of that fund's return for the year to date. Netflix accounted for nearly a third of the Vanguard Consumer Discretionary ETF (VCR return for the year to date.
Once the reclassification is finalized those stocks will no longer be held in their respective Vanguard sector ETFs. As a possible result of this, Vanguard has laid out a transition plan which is noted on its website.
Other technology-focused ETFs are less stringent about sticking to only stocks categorized in the information technology sector. As such, they may track an index with a broader investment universe and could maintain allocations to those stocks.
While this change does not impact most investors, it may significantly impact some. For those invested in passively managed sector funds, it's very important to understand how these changes will be implemented and what impact it will have on holdings.
By: Cara Esser, CFA
Esser is a senior investment research analyst and investment committee member in Mesirow Financial's Retirement Planning and Advisory group.