The Impact of the GICS Classification Changes
Some tech stocks are now labeled "Communications Services"
In September of 2018, there was a meaningful change to the way many stocks are categorized, potentially impacting anyone who invests in technology and communications stocks.
In what is being hailed as one of the biggest changes to stock classifications since the current 11-sector system was put into place nearly 20 years ago, many recognizable tech stocks will now officially be considered communications companies.
In short, the telecommunications sector has been re-named “Communications Services” and will include some companies formerly from other sectors, including tech. As much as 10 percent of the entire market capitalization of the S&P 500 has been impacted by this change.
The sectors outlined by the Global Industry Classification Standards have been used since 1999 and are used by S&P Dow Jones and the MSCI, which publish most of the major stock market indices worldwide.
The Basics of the Change
In short, the changes to classifications can be summarized as follows:
- Telecommunications is now known as Communications Services
- Many information technology stocks will move to the new Communications Services sector
- Some consumer discretionary stocks will also move to Communication Services
- Online marketplaces, such as eBay, will move from information technology to consumer discretionary
According to one analysis by Bloomberg, more than 20 percent of the market cap of consumer discretionary stocks and a similar percentage of information technology stocks will be moved to the new Communications Services sector. This includes recognizable companies such as Comcast, Disney, Alphabet (Google), Facebook, and Netflix.
There are many reasons for this change, but the main impetus is that the information technology sector was getting very large, suggesting that many stocks deserved to be reclassified. Moreover, some companies, such as Facebook and Google, have evolved to resemble communications firms rather than simply tech firms.
Initial analysis suggests that this change will boost the new Communications Services sector in the S&P 500, while decreasing the presence of information technology. Prior to the change, information technology made up about 25 percent of the S&P 500, but now it comprises about 20 percent, according to Bloomberg. Meanwhile, the former telecom sector once comprised 1.9 percent of the S&P 500, but will now make up 10.2 percent, potentially making it the fourth-largest sector overall.
Historically, if you want to get a sense of how a sector might perform, you can examine past prices. But making such comparisons now will be very difficult, as the makeup of the sectors will be very different moving forward.
A Defensive Sector Becomes More Volatile
The former telecommunications sector was once seen as one of the more stable parts of the stock market, because it included many dividend stocks that avoided large swings in stock price. AT&T is perhaps the poster child for this kind of company. In fact, many investors purchased stocks in the telecommunications sector instead of purchasing U.S. Treasury bonds, because the stocks offered similar stability and income potential.
But the new communications sector is likely to become more cyclical and more volatile, thanks to the addition of large tech firms like Alphabet and Facebook. In fact, the new sector can no longer be considered a “defensive” sector, but will have much greater sensitivity to the movement of the overall stock market.
One analysis by Fidelity Investments notes that the new communications sector will be four times as market sensitive as its predecessor and that the information technology sector is now nearly 20 percent less market sensitive. Moreover, the average dividend yield for the sector will likely decline dramatically. This is a significant development for those investors who are close to retirement and may be seeking to preserve their nest egg. For older investors and others looking to protect their money, no longer will it make sense to invest in a mutual fund focused on the communications sector.
Sector-Based Investing Is Still Smart
Despite all these changes, it’s important to note that eight out of the 11 sectors are unchanged moving forward. The overall approach of investing in sectors still makes sense. It’s much easier to invest in sectors of the stock market through things like mutual funds and exchange-traded funds than to buy shares of individual companies. Even with the changes, investing in sectors can provide broad exposure to a wide variety of firms and bring great diversity to your portfolio.
It’s worth noting that the managers of mutual funds and ETFs may very well ignore the new classifications when constructing their portfolios. A fund advertised as being focused on technology can still invest in Netflix or Facebook, for example. Thus, it remains important for all investors to review the holdings of any fund before buying shares.