S&P Dow Jones Indices is the company which maintains the GICS — the Global Industry Classification System. That system assigns companies to specific industry groups; it’s important because so many exchange-traded funds are grouped together on the basis of these classifications. That can mean that many stocks get caught in updrafts or downdrafts because of the performance of other companies that are dominant in their industries. It can matter a lot whether Amazon [NASDAQ: AMZN] is a bedfellow in your index.
Speaking of AMZN, which industry is it classified in? Surprisingly, not information technology — it’s in with the consumer discretionary stocks including old-line retailers. There are plenty of other classifications that look a bit accidental. Perhaps they made sense twenty years ago, but economic reality has moved on and has resulted in some strange bedfellows.
So the GICS, effective September 21, is making some big changes. A big group of tech names — including Alphabet [NASDAQ: GOOG], Facebook [NASDAQ: FB], Activision Blizzard [NASDAQ: ATVI], and Twitter [NASDAQ: TWTR] are leaving the company of other tech stocks and migrating to the new “Communications Services,” settling in with the remnants of the old (and now defunct) “Telecom Services” classification.
Will this make a dramatic difference? There could be some near-term volatility which traders will attempt to exploit, as shares are sold ahead of September 21. Longer-term, there could be effects such as a boost for the likes of Verizon [NYSE: VZ] and AT&T [NYSE: T], which suddenly find themselves grouped with strong and innovative growth companies.
However, there could also be a benefit to tech stocks themselves. Most active institutional money managers have mandates which direct that they must stay within certain sector weights. They might want to own more tech, because it has been a growth and earnings powerhouse, but have been restrained from doing so by their sector weight limitations. Now, they will be able to own companies that are “really” tech companies, and yet formally, will be “communications services” companies. In short, the reclassification could actually serve to permit more overweighting of tech stocks by active managers. For awhile, that could be a strength; but when the end of the current bull market finally arrives, it could also work in the reverse direction — pulling down companies like the old telecoms that formerly served as defensive bastions.
Investment implications: As new industry classifications are applied in the rebalancing of index funds on September 21, there could be some transient volatility. More importantly, if you hold index funds, particularly tech and consumer discretionary, you should be aware of how the composition of your funds has changed since the new classifications were made, and consider an allocation to a new Communications Services sector fund. It’s always important to know the dominant constituent stocks of index funds that you hold, as well as the large companies whose presence in the index could affect your individual stock holdings. Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. Currently, Guild’s principals and clients own AMZN, ATVI, FB and GOOG. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.