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A major shakeup to the way index providers divide stocks by industry will force many investors to rethink how their portfolios are put together when the changes take effect later this month.

More than 2,100 stocks around the world, encompassing about US$4-trillion in total market value, will be reclassified or shuffled into different sectors, altering the makeup of sector-specific indexes and the funds that track them.

Starting on Sept. 24, investors will be introduced to the “communications services” sector, built from the existing telecom sector, plus a number of other stocks drawn from the tech and consumer discretionary sectors.

As a result, investors who target specific sector weightings will soon be working with a different set of building blocks. “It will change the way people will approach portfolio diversification a little bit,” said Ryan Modesto, chief executive of independent firm 5i Research.

The new communications sector will be unlike its telecom predecessor, Mr. Modesto said. “What you expect that sector to do for your portfolio is going to be much different now.”

The overhaul of the Global Industry Classification Standard (GICS), which is a system that both S&P and MSCI use to categorize stocks and build indexes, was brought on by a desire to break up the tech sector.

“Technology has advanced to the point that a line should be drawn between those who use technology and those who produce technology,” writes Brad Sorensen, an analyst at Charles Schwab.

Currently under a common banner, those two groups of stocks have inflated the tech sector into the single largest weighting in the global stock market.

At about 20 per cent of the MSCI All-Country World Index, and 26 per cent of the S&P 500 Index, tech stocks have assumed a profile unseen since prior to the bursting of the dot-com bubble.

With the FAANGs – Facebook Inc., Apple Inc., Inc., Netflix Inc. and Google-parent Alphabet Inc. – among the stocks driving major indexes higher in recent years, S&P and MSCI have agreed to split the tech sector.

Current tech components that will be joining telecoms in the new sector include internet companies such as Facebook, Alphabet and Twitter Inc. Also moving are media and entertainment stocks currently residing in the consumer discretionary sector, including Netflix and Walt Disney Co.

The overhaul will be applied globally, with S&P indexes that use the GICS classifications rebalancing as of the market open on Sept. 24, while MSCI indexes will update in November.

In Canada – a market still dominated by resources and financial stocks – the changes will be minimal. There are currently no Canadian tech names that would qualify for inclusion in the communications sector.

But there are some media names in the S&P/TSX Composite Index that will be moved out of the consumer discretionary sector, including Shaw Communications Inc., Quebecor Inc., Cogeco Communications Inc., Cineplex Inc., and Corus Entertainment Inc.

Outside of Canada, the rebalancing will be much more substantial. The tech sector will relinquish its top weighting within the MSCI All-Country World Index, with its share falling to about 15 per cent, moving financials in to the No. 1 spot at about 17.5 per cent, according to BlackRock Inc.

In the United States, some of the big stocks being relocated will carry with them some premium valuations.

Traditionally, the telecom sector has served as a defensive pocket of the market. Additionally, telecoms have offered generous dividends appealing to income investors.

Within the S&P 500 Index, the telecom sector’s dividend yield of 5 per cent will drop to about 1 per cent, according to a recent analysis by Ned Davis Research. And the communications sector will be heavily weighted in tech stocks, with more than half of its market value based in former IT names, BlackRock said.

“That’s a much different risk profile than your classic dividend-paying telecom,” Mr. Modesto said.

The shuffle will also force several funds that track individual sectors to adjust their holdings.

“If you hold sector-specific funds for the discretionary or tech sectors, you could already be seeing some selling of the stocks that are moving out of those sectors in order to stay within the funds’ mandate,” Mr. Sorensen said.

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