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Your index is changing and you may not even know it

Ryan Modesto, CFA, is CEO at 5i Research, a conflict-free investment research provider for retail investors offering research reports, model portfolios and investor Q&A, which is available to try for free. 5i Research provides content under an agreement with The Globe and Mail, which receives royalty compensation.

The largest index providers have recently announced changes that could have big implications for investor portfolios, and even on the markets, at least in the short-term. Now that technology is really a part of every company and the lines between "tech" companies and "other" becomes increasingly blurred, the S&P and MSCI indexes are altering the classifications of companies within the industries.

More specifically, as of Sept. 28, 2018, the Global Industry Classification Standard (GICS – the group that determines which stocks go into which industries) will be making some pretty substantial changes:

  • Telecommunications sector: This will be renamed “communication services” and include media assets that were typically grouped under “consumer discretionary.”
  • Information-technology sector: Many stocks that are currently classified as “tech” companies will see a shift to either communication or consumer-related industry classifications. To help illustrate a bit more accurately what impact this will have, we have highlighted a few notable companies that will see changes in the accompanying table.

There are a lot more changes happening here, but we thought this is a good representation of the names that most will recognize. It is important to note these are not small adjustments around the margins or small companies. These changes move some of the world's largest and best-performing companies into totally new classifications. Here are some implications that investors, big and small, will need to consider:

Your back-tests are rendered useless

To keep the example simple here, let's say you have launched a tech-focused mutual fund and to help market it you looked at past performance of the tech industry showing it has outperformed all other industries. Because of this, part of your mandate is that the fund can only hold stocks in the technology sector. As of the end of September, that back-test will no longer be reliable since it would include companies such as Facebook and Alphabet, which will no longer be part of the tech industry but instead considered communications services. What's more, the companies that would typically be "growthy tech" names could possibly be plunked into communication services, affecting the actual potential growth rates of the industry as a whole. This changes any and all assumptions that the technology sector will be the high growth sector in the future. Some interesting questions arise here: Will future back-tests have an asterisk saying it includes names such as Facebook and Alphabet in the IT sector? Will old back-tests have a caveat that some of the largest contributors to performance of the tech sector in the past no longer remain in the sector? Will a technology fund/ETF be able to make exceptions and continue to be able to hold some "traditional" technology names?

The reason you purchased a fund or ETF may no longer be relevant

Many investors will/have purchased a tech ETF to get quick and easy exposure to the "FANG" stocks such as Facebook, Amazon, Netflix and Google/Alphabet. After these changes, this strategy will likely not be quite as effective as it has been. An investor may be required to dig into the underlying holding of their funds to ensure they still hold the stock(s) that they want to hold or that they thought they were holding.

What you have assumed about an industry may now change

Some general rules investors use are ideas such as if you want more growth in a portfolio, you own tech names. If you want stability and dividends, you own telecommunications names. Now with some of the largest companies and higher-growth companies getting moved from IT to communication services, you have a big shift in these assumptions. You have a growth tilt going into a sector that is usually used for a more defensive allocation (telecommunications). While a few companies do not make an industry, in the case of the FANG names, they certainly have been big contributors to performance. Furthermore, there is no guarantee that the next set of "FANG" stocks, whatever they may be, will be part of what is typically the higher-growth IT sector. Over all, the reasons an individual has an allocation to a certain sector or owns a sector fund may now be different.

Your industry allocations will likely need to change

Given all of the changes to the industry classifications, investors will need to revisit their portfolio allocations. This offers a good opportunity to sit down with an adviser to review your portfolio, or in the case of a DIY investor, to take some time to review your portfolio allocations. As an example, if you initially were comfortable with a 5-per-cent telecommunication allocation, you may want/need to up that to 10 per cent once several companies are reclassified as communication services. Someone who wanted more growth through the tech sector may find it appropriate to balance things out a bit more into other sectors.

Over all, these changes look to be for the better. It recognizes that the world is changing and that technology is becoming integrated in all companies. It does, however, make things a little confusing for investors in the shorter term. We often see investors get hung up on what to classify a company as, since many names do not fit cleanly into one sector. Our two cents on this is not to get too caught up into naming conventions at the end of the day. Keep total industry allocations in check, but if you have found a great company with solid fundamentals that looks a bit like it is in industry X and a bit like industry Y, we would rarely if ever avoid owning that name just because it is classified one way or another. So be aware of these coming changes and how they may affect your portfolio and retirement goals, but do your best to not get so bogged down that you can no longer see the forest for the trees.

Key stocks that will be reclassified

Company NameCurrent GICS SectorNew GICS Sector
Comcast Corp.Consumer DiscretionaryCommunication Services
Time Warner Inc.Consumer DiscretionaryCommunication Services
Twenty-First Century Fox Inc.Consumer DiscretionaryCommunication Services
Viacom Inc.Consumer DiscretionaryCommunication Services
Walt Disney Co.Consumer DiscretionaryCommunication Services
NetFlix Inc.Consumer DiscretionaryCommunication Services
TripAdvisor Inc.Consumer DiscretionaryCommunication Services
Alibaba Group Holding Ltd. ADRInformation TechnologyConsumer Discretionary
Baozun Inc. ADRInformation TechnologyConsumer Discretionary
eBay Inc.Information TechnologyConsumer Discretionary
Alphabet Inc.Information TechnologyCommunication Services
Baidu.com ADRInformation TechnologyCommunication Services
Facebook Inc.Information TechnologyCommunication Services
Twitter Inc.Information TechnologyCommunication Services
Yelp Inc.Information TechnologyCommunication Services
Snap Inc.Information TechnologyCommunication Services

Source: MSCI

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