Later this month, there will be significant changes to the economic sectors that make up the S & P 500 index. In 1999, MSCI introduced the Global Industry Classification Standard (GICS®) methodology. This is a means of classifying companies by industry and sector that has become widely adopted. Over the years they have made periodic changes as the economy continues to evolve.  Most recently, in 2016, they added Real Estate as the 11th economic sector. Prior to that time, Real Estate was encompassed within the Financials sector. This was the first new sector since the 1999 introduction of GICS.

The upcoming changes will affect about 10% of the market capitalization (size) of the S & P 500 index. The overall number of sectors will remain at 11, but many companies will be moving from one sector to another. The main change is that the Telecommunications Services sector is being broadened and renamed Communications Services. Currently, 95% of the market capitalization of the Telecommunications sector is represented by just 2 stocks: Verizon and AT&T. It is also a relatively small sector at about 1.8% of the S & P 500. The logic behind the change, as described by MSCI, is that there has been a significant evolution in the way people communicate and access information and entertainment content. At the same time, the traditional landline business continues to decline. The new sector will contain traditional telecom companies, cable, media, and content providers, video game makers, as well as advertising and broadcasting firms and some others. It will be the 4th largest sector in the index.

Below is a summary of major changes, and the impact on the sector weights within the S & P 500:

Telecommunications Services sector:  From 1.8% to 0% (renamed Communications Services).

Communications Services: From 0% to about 10%.  Will contain AT&T, Verizon, Alphabet (Google), Facebook, Netflix, Disney, Comcast, and others.

Information Technology:  From 26% to 20% (but will still be the largest sector). Coming Out:  Alphabet, Facebook, Twitter, eBAY, and video game makers: Activision Blizzard, Electronic Arts, and Take Two Interactive Software. The sector will be smaller, but Apple will have a larger weight since other companies are leaving. Going In: None.

Consumer Discretionary: From 13% to 10%: Coming Out: Disney, Comcast, Viacom, CBS, Discovery, Fox, Viacom, News Corp, Charter Communications, Netflix, and Trip Advisor. Going In: eBAY. The sector will be smaller, but Amazon will have a larger weight since others are leaving.

The changes are currently scheduled to occur after the close of trading on September 28th. However, some index providers like Vanguard have already migrated their mutual funds and exchange-traded funds (“ETFs”) to the new sector over the last several months. State Street, who manages the popular SPDRs line of ETFs, introduced a new ETF for the sector back in June and will rebalance holdings within other ETFs as of the close of business on September 21st.

What are the implications of these changes from a portfolio management standpoint?

We will not be making trades in client portfolios in anticipation of these changes. In our opinion, the changes are not actionable from an investment standpoint in a fashion that would allow our clients to profit. Our focus is on long-term investing instead of short-term trading. Rather, we continue to focus on identifying quality companies with the potential to grow their earnings and dividends over time.

There is some impact to the timing of when we review various companies as part of our research process. It actually makes it a bit easier, since the number of companies will be more evenly divided between sectors. Also, for our portfolios that contain individual stocks, we will adjust our sector targets that our portfolio managers use when determining whether client portfolios are over or underweight.

What does all of this mean to investors?

Think of it as a pizza sliced different ways: they are going from a New York style cut of triangular pieces to a Chicago style (thin crust) that is cut in a cross-hatched fashion. But the overall size of the pizza remains the same.

Bill Hansen, CFA

President and Chief Investment Officer