Investment

Time for a Change

EFTs and 2018 GISC Refresh

Invest-Notes continues to forcefully urge that individual investors anchor their investment and retirement portfolios around exchange-traded funds (ETFs). Specifically, indexed funds of the S&P 500 and international blue-chip stocks. Around this central component, it might make sense to add specialty funds, like those comprised of medical companies (for growth) or utilities (for yield). For the truly adventurous, and being mindful of the risks involved, having a handful of individual stocks can also make sense.

Individual stocks of major companies will find that on September 30, 2018, the description of what business they are in will change. This is not as odd as it might sound. Netflix started as a business to rent DVDs by mail. Disney made cartoons. AT&T was the phone company. Today Netflix has something like 125 million subscribers to a streaming video service that not only offers the same movies they used to rent but creates more custom content than the three TV networks combined. Disney now owns theme parks and ESPN. AT&T just bought Time Warner, go figure. As businesses evolve, so should the way in which we invest in them.

During the formative years of Invest-Notes, there was often discussion of specific trades. After the market mayhem of 2008-2009, not so much so. The shift in focus went from what to trade, to how to trade. This idea of talking about ways to make smart investments by thinking about our behavior will continue, but right now we’re going back to being very prescriptive about a specific investment idea.

New kid on the block

There is about to be a brand-new industry sector that will be composed of big companies coming from other sector funds. This matters, because the Big Daddies of indices, S&P Dow Jones and MSCI, use the GICS stock classifications to determine things like whether Home Depot should be identified as a Consumer Staple, or a Consumer Discretionary stock. In their turn, the Big Daddies of exchange-traded funds, like State Street and Vanguard, use these sector definitions of the S&P 500 and MSCI to decide what stocks will be included in the ETFs that individual investors are buying in ever-increasing amounts.

As a quick reminder, the Global Industry Classification Standard (GICS), is a worldwide standard for stock classification. Established in 1999 with ten sectors, the GICS started with: Consumer Discretionary; Consumer Staples; Energy; Financials; Health Care; Industrials; Technology; Materials; Telecom; and, Utilities.

ETFs-2017 GISC sp-500 sector weight

source: https://us.spindices.com/

The only change to this line-up occurred in August of 2016 when the Financial sector was bifurcated to create a Real Estate sector. Discussed here at that time in our article, “The Difference Between Banks and Buildings“, it should be noted that while Invest-Notes correctly identified the pros and cons of the change, we totally whiffed on guessing the subsequent performance of the two sector funds.

The transition taking place on September 30, 2018, is more impactful since it will see three sectors facing major changes to their composition. First, Telecom Services will be renamed Communications Services. Currently, the smallest of the eleven GICS sectors composed of only the stocks in the S&P 500, when Telecom becomes Communications it will grow from 2% of the index to around 10%. The challenge for investors is determining what to do with current sector holdings when some of the biggest stocks in the S&P get shuffled around. Google, Verizon, and Disney are not niche investments. In point of fact, the top holdings in the soon to be Communications Services sector comprise about 10% of the S&P 500.

Now, what happens to the Information Technology Sector when Google, Facebook, and other heavy hitters are no longer part of Technology ETFs and become components in the new Communication Services Sector? Or the Consumer Discretionary Sector (a sizable ETF holding in my personal accounts), where Netflix, Disney, and other big companies will be moving out. And is it a good bet to add one of the big Telecom ETFs – IYZ or VOX – in advance of the reshuffle?

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