While there will still be 11 GICS sectors, the Telecommunication Services
sector will be renamed Communication Services. Along with its new name, its
profile will be expanded to include companies from Consumer Discretionary
and Information Technology, which will add growth to a sector that has
traditionally been seen as a value play.1
To explore the potential impact of these shifts on sector investing, we
performed an analysis of new sectors based on the currently known list of
large-cap companies expected to be impacted by the upcoming changes.
To create the new sectors, we reallocated these companies to their new
sectors and then weighted them by market cap. Next, we took a bottom-up
approach, capturing historical information at the stock level and
aggregating it at the sector level. This allowed us to avoid back testing –
our analysis represents historical information repackaged under a different
The resulting five charts shown below illustrate how these changes will
likely impact GICS sectors and sector investing going forward.
Telecommunication Services gets a makeover
The new Communication Services sector will include companies that
facilitate communication and offer related content and information through
various types of media. This is an upgrade of the Telecommunication
Services sector, allowing it to reflect modern communication activities.
The revamped sector will include existing telecommunication companies, such
AT&T (NYSE: T), as well as former media-related Consumer Discretionary stocks, such as
Netflix Inc. (NASDAQ: NFLX), and consumer internet-oriented Information Technology stocks, like
Facebook Inc. (NASDQ: FB).
This means FAANG (Facebook, Apple, Amazon, Netflix, and Google) will be
redistributed across three sectors as opposed to two. The Communication
Services sector will represent around 10% of the S&P 500® Index market
cap, compared with the 2% weight of the current Telecommunication Services
More growth options for sector investors
Historically, the Telecommunication Services sector was viewed under a
“value” lens due to its number of bond-proxy, high-dividend-paying stocks.
However, certain high-flying FAANG stocks will be removed from Consumer
Discretionary and Information Technology to join Communication Services.
This means Communication Services may be viewed under the “growth” lens
based on a style exposure analysis we conducted using Morningstar Style Box
classifications. As shown in Chart 2, Telecommunication Services is
currently classified 100% as a value sector. When it becomes Communication
Services, it will hold a majority – 57% – of growth stocks, as shown in
But these changes do not completely strip growth from Consumer
Discretionary and Information Technology. They will have a 58% and a 49%
allocation to growth stocks, respectively – figures that are higher than
the broader market.
The fundamentals of change: Higher growth, lower leverage at attractive
Communication Services’ growth tilt is reinforced when examining the
historical growth rates of its underlying companies and their consensus
analyst estimates for the next three to five years.
Shown in Chart 3, the new sector will result in a portfolio of stocks that
have produced – and are expected to produce – a high level of earnings and
sales growth. These growth rates are projected to be above that of the
The new sector will also have far less leverage, as measured by the
long-term debt-to-capital (LTC) percentage. Its LTC will be 28% vs. its
current rate of 62%. But the leverage profile of the other two sectors only
shifts slightly, with Consumer Discretionary rising from 51.4% to 52.7% and
Information Technology increasing from 30.3% to 37.4%.2
Growth at what cost?
This raises the question: What is the price associated with these new
growth dynamics? To answer this, we chose four fundamental metrics, while
also comparing the current aggregated sector level Price-to-Earnings (P/E)
ratio versus the same group of stocks historical average P/E ratio over the
past 10 years. The latter point may provide insight into whether the new
sector will be more expensive, fundamentally speaking, versus what history
As shown in Chart 4, the Communication Services sector trades at higher
multiples than the old sector while the other two sectors’ fundamentals
remain largely the same. Compared to the 10-year average, all new versions
of the sectors are trading above their historical average. However, when
each sector is viewed relative to the market, a relative value opportunity
exists, as each sec tor is trading at a lower premium to the S&P 500
than their historical average over the last 10 years.
Sectors are also closely aligned to specific economic variables. Chart 5 shows the beta of the new and current sectors based on sector
constituents’ beta. The Communication Services sector will be more
sensitive to the broad market, less negatively sensitive to the U.S. dollar
while more positively sensitive to the U.S. 10-year Treasury yield. While
the latter move is small, it illustrates that this new set of communication
stocks will not be the typical bond proxies of the current
The Communication Service’s shift in beta sensitivity to the U.S. dollar is
representative of its increased tech-like global footprint. The previous
sector had only 2.9% of foreign sales. The new one will have 32%. 3
Sector due diligence will need an upgrade
These upcoming GICS changes mean sector growth opportunities will become
more widespread. They also mean the Communications Services sector will be
more cyclical than Telecommunication Services, which was more defensive.
Unfortunately, this sector revamp also means performing a bottom-up
fundamental analysis or a top-down macro analysis will become harder.
Investors can no longer simply run a screen based on historical values
because the Informational Technology sector from the last 10 years will
look different for the next 10. Trend-following rotation strategies will
also have to course-correct given that the new Communication Services
sector will have 13 constituents that rank in the top 50% of performers in
the S&P 500 over the past year4 – while the old
Telecommunication Services sector had none.
1. “S&P Dow Jones Indices and MSCI Announce Revisions to the Global
Industry Classification Standard (GICS) Structure in 2018,” msci.com, as of
2. FactSet, as of 1/11/2018
3. FactSet, as of 1/1/2018
4. FactSet, as of 1/11/2018
Measures the volatility of a security or portfolio in relation to the
market, usually as measured by the S&P 500 Index. A beta of 1 indicates
the security will move with the market. A beta of 1.3 means the security is
expected to be 30% more volatile than the market, while a beta of 0.8 means
the security is expected to be 20% less volatile than the market.
Global Industry Classification Standard (GICS):
A financial-industry guide for classifying industries that is used by
investors around the world. The GICS structure consists of 11 sectors, 24
industry groups, 68 industries and 157 sub-industries, and Standard &
Poor’s (S&P) has categorized all major public companies into the GICS
S&P 500 Index:
The S&P 500, or the Standard & Poor’s 500, is an index based on the
market capitalizations of 500 large companies having common stock listed on
the NYSE or NASDAQ. The S&P 500 index components and their weightings
are determined by S&P Dow Jones Indices.
Sector rotation is a strategy based on moving investments across business
sectors to take advantage of cyclical trends in the overall economy whereby
a portfolio may overweight positions in strong sectors and underweight
positions in weaker sectors.
Bobby Eng is Vice President – Head of SPDR ETF Business Development
State Street Global Advisors. This article is reprinted from the Spring 2018 issue of
Your Guide to ETF Investing, published by Brights Roberts Inc. Reprinted with permission.
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