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The Times They Are A Changin’

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Creation of a New Sector: Communication Services

S&P Dow Jones Indices and MSCI are respon­si­ble for the devel­op­ment and main­te­nance of the Glob­al Indus­try Clas­si­fi­ca­tion Stan­dards (“GICS”). Near the end of 2017 they announced the cre­ation of a new sec­tor, Com­mu­ni­ca­tion Ser­vices. This new sec­tor will be com­prised of stocks cur­rent­ly in Infor­ma­tion Tech­nol­o­gy, Con­sumer Dis­cre­tionary, and Tele­com sec­tors.

This change was designed to reflect the ever-chang­ing nature of our econ­o­my. As social media, inter­net ser­vices, and inte­grat­ed media & enter­tain­ment com­pa­nies take a big­ger role in our lives, a new sec­tor was deemed nec­es­sary to cap­ture these changes. This is one of the biggest changes to the GICS struc­ture since its incep­tion.

S&P 500 Sector Weights Before After - Times are a Changin - Swan Insights

Source: State Street, MSCI, S&P Dow Jones

The State Street Glob­al Advi­sors Select Sec­tor SPDRs ETFs are designed to track the GICS indices. In order to accom­mo­date this change, SSgA has cre­at­ed the Com­mu­ni­ca­tion Ser­vices Select Sec­tor SPDR Fund with the tick­er XLC. When the reclas­si­fi­ca­tion of those stocks into Com­mu­ni­ca­tions Ser­vices occurs on Sep­tem­ber 21, 2018, just over two dozen names will be sold out of the exist­ing ETFs and then only avail­able in the XLC ETF.

 

What are the stocks that are being reclassified?

The new XLC ETF will con­tain the fol­low­ing. Weights are esti­mates, and change based upon dai­ly price fluc­tu­a­tions.

XLC Holdings Breakdown - Times are a Changin - Swan Insights

Source: Morn­ingstar Direct, 7/30/18

 

The Sector Change and the Defined Risk Strategy

Swan cur­rent­ly uses the line-up of SSgA Select Sec­tor SPDRs to gain access to the U.S. Large Cap mar­ket in its flag­ship Defined Risk Strat­e­gy offer­ing. Each sec­tor is giv­en a tar­get weight­ing equal to the oth­ers. With nine pri­ma­ry sec­tors avail­able, each sec­tor cur­rent­ly has a tar­get allo­ca­tion of 11.11% of the total equi­ty allo­ca­tion[1].

With the cre­ation of the new Com­mu­ni­ca­tion Ser­vices ETF, Swan plans to main­tain its equal-weight approach across the pri­ma­ry sec­tors. So rather than nine sec­tors with 11.11% each, there will be ten sec­tors with a tar­get of 10.00% each[2].

 

Swan Global Equal Weight Before After - Times are a Changin - Swan Insights

Source: Swan Glob­al Invest­ments

 

So essen­tial­ly 1.1% will be shaved off of every exist­ing sec­tor and allo­cat­ed to XLC.

This change is sim­ply too big to ignore. If Swan were to exclude XLC from its allo­ca­tion, it would be miss­ing a sig­nif­i­cant part of the mar­ket, includ­ing some of the biggest names in the S&P 500.

 

What will the impact be from a top-down, total portfolio basis?

The equal weight sec­tor approach gives the aggre­gate port­fo­lio more of a val­ue-tilt and a lean away from some of the mega-cap names that dom­i­nate the S&P 500. Sec­tors like heath care, finan­cials, and most notably tech­nol­o­gy are under­weight­ed. More val­ue-ori­ent­ed sec­tors like ener­gy, util­i­ties, and mate­ri­als are over­weight­ed.

Post reclas­si­fi­ca­tion, the revised equal weight will still have a bias towards val­ue and away from mega-cap, but the dif­fer­ence will not be as pro­nounced. This change moves the aggre­gate port­fo­lio a lit­tle clos­er to the S&P 500 in some ways. Because 1) many names in the new­ly cre­at­ed Com­mu­ni­ca­tions Ser­vices sec­tor will be sourced from the Tech­nol­o­gy sec­tor and 2) the tar­get weight for Com­mu­ni­ca­tions Ser­vices is now a full 10%, the over­all expo­sure to the “new econ­o­my” names will increase.

If one cre­at­ed a spec­trum with val­ue on one side and growth on the oth­er, it might look like the fol­low­ing:

Equal Weight Spectrum - Times are a Changin - Swan Insights

What will be the impact from a bottom-up, individual stock basis?

The upper half of the table below shows esti­mates of the five biggest over- and under-weight­ed posi­tions rel­a­tive to the S&P 500. The low­er half shows the same infor­ma­tion after the reclas­si­fi­ca­tion.

S&P DRS Weight Comparisons - Times are a Changin - Swan Insights

Source: Swan Glob­al Invest­ments, Bloomberg

 

Those posi­tions that move from Tech­nol­o­gy to Com­mu­ni­ca­tion Ser­vices get the biggest boost. Those names that remain in Tech­nol­o­gy make up a larg­er slice of a now small­er pie, so they get a slight increase.

The top over­weights are slight­ly reduced by the reclas­si­fi­ca­tion. In fact, it is not just the top five — it is almost all of the over­weights. Even though many of the sec­tors are not impact­ed by the reclas­si­fi­ca­tion at all, the fact that Swan will be reduc­ing the stan­dard weight from 11.1% to 10.0% reduces many over­weight posi­tions and slight­ly increas­es some under­weight posi­tions in sec­tors like Finan­cials and Health­care.

 

What will be the tax consequences?

When it comes to tax­es, there are two top­ics to dis­cuss: the impact of the change with­in the ETFs like Tech­nol­o­gy (XLK) and Con­sumer Dis­cre­tionary (XLY) and the impact as Swan rebal­ances from 11.1% to 10.0% weight­ings as the Com­mu­ni­ca­tion Ser­vices ETF (XLC) is added.

State Street Glob­al Advi­sors has stat­ed that they expect lit­tle to no impact from rebal­anc­ing XLK and XLY and mov­ing those two dozen names over to XLC.

When it comes to Swan adjust­ing the equal weight sec­tor tar­gets from 11.1% each to 10.0%, the tax impact is also expect­ed to be min­i­mal com­pared to reg­u­lar rebal­ances. The exist­ing tar­gets are only being reduced by 1.1% each. In addi­tion, Swan has car­ry for­ward loss­es from past years’ put options from hedg­ing the port­fo­lio.

More­over, due to the dai­ly price moves on the var­i­ous sec­tors, the actu­al allo­ca­tions to the sec­tors are often a bit dif­fer­ent from their tar­gets. Swan mon­i­tors these actu­al allo­ca­tions and when they drift too far will ini­ti­ate a rebal­ance back to tar­get.

With the addi­tion of XLC to the port­fo­lio, this will cre­ate a sit­u­a­tion where most of sec­tors will like­ly be slight­ly off-tar­get. Using their exist­ing rebal­anc­ing infra­struc­ture, Swan plans to give XLC its tar­get­ed 10% allo­ca­tion by slight­ly reduc­ing all oth­er sec­tors.

 

Why does Swan equal-weight the sectors in the first place?

Since 2012 Swan has opt­ed to equal­ly weight the var­i­ous GICS sec­tors rather than use the cap­i­tal­iza­tion weight­ed S&P 500 for its mar­ket expo­sure. The Achilles Heel of cap­i­tal­iza­tion-weight­ing is that the only thing that mat­ters is a company’s price. The more a company’s stock price goes up, the big­ger the com­pa­ny gets, the more a cap-weight­ed index is forced to buy it. This cre­ates a pos­i­tive feed­back loop that can lead to bub­bles in sec­tors or indi­vid­ual stocks. The equal-weight­ed approach is a way to intro­duce more of a val­ue-tilt into the port­fo­lio.

A full dis­cus­sion of equal-weight sec­tors can be found in these two blog posts:

Worth the Weight

Worth the Weight, Q&A

 

Differences from the Real Estate sector change and carve out (XLRE) in 2016

In 2016, S&P and MSCI had a reclas­si­fi­ca­tion where they cre­at­ed a sec­tor for Real Estate. There are two key dif­fer­ences between the Real Estate reclas­si­fi­ca­tion two years ago and the pend­ing Com­mu­ni­ca­tion Ser­vices.

  1. All of the REIT stocks that went into Real Estate were sourced from the Finan­cials sec­tor
  2. The over­all REIT sec­tor, rel­a­tive to the mar­ket, was rather small (2.9%)

With the Com­mu­ni­ca­tion Ser­vices reclas­si­fi­ca­tion, stocks are migrat­ing over from mul­ti­ple sec­tors, name­ly Infor­ma­tion Tech­nol­o­gy, Con­sumer Dis­cre­tionary, and Tele­com. More­over, the new sec­tor will be a sig­nif­i­cant part of the S&P 500, antic­i­pat­ed to be around 10% of the mar­ket. It could be argued that the Real Estate carve-out was unnec­es­sary.

Two years ago, Swan made the deci­sion to keep the rel­a­tive weights between the Finan­cials ETF (XLF) and the new­ly cre­at­ed Real Estate ETF (XLRE) in rough­ly the same 4:1 ratio they were before the carve out. The com­bined XLF/XLRE posi­tion was kept at its orig­i­nal 11.1% weight, since those stocks in the past had always been clas­si­fied as Finan­cials.

 

 

Learn More about the Communication Services Reclassification

State Street Glob­al Advi­sors has pro­duced a wealth of infor­ma­tion on this top­ic. A good start­ing point would be these links:

https://us.spdrs.com/en/etf/communication-services-select-sector-spdr-fund-XLC

https://global.spdrs.com/blog/post/2018/jun/communication-services-investing-to-reflect-a-new-reality-gics-sector-changes-part-1.html

https://global.spdrs.com/blog/post/2018/jun/a-new-gics-sector-is-on-its-way-how-to-prepare-portfolios-gics-sector-changes-part-2.html

https://www.etftrends.com/new-sector-spdr-etf-debuts-with-3-faang-stocks/

 

About the Author:

Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Client Portfolio Manager - Swan Global InvestmentsMarc Odo, CFA®, CAIA®, CIPM®, CFP®, Client Port­fo­lio Man­ag­er, is respon­si­ble for help­ing clients and prospects gain a detailed under­stand­ing of Swan’s Defined Risk Strat­e­gy, includ­ing how it fits into an over­all invest­ment strat­e­gy. For­mer­ly, Marc was the Direc­tor of Research at Zephyr Asso­ciates for 11 years.

 

 

 

 

Important Notes and Disclosures:

[1] An excep­tion is made to the roles of real estate (XLRE) and finance (XLF). The two have a cur­rent com­bined weight of 11.11%. This is dis­cussed in greater detail towards the end of this FAQ.

[2] The excep­tion for real estate and finance will be main­tained. The two will have a com­bined allo­ca­tion of 10%.

 

Swan Glob­al Invest­ments, LLC is a SEC reg­is­tered Invest­ment Advi­sor that spe­cial­izes in man­ag­ing mon­ey using the pro­pri­etary Defined Risk Strat­e­gy (“DRS”). SEC reg­is­tra­tion does not denote any spe­cial train­ing or qual­i­fi­ca­tion con­ferred by the SEC. Swan offers and man­ages the DRS for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non-qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997, and are net of fees and expens­es. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®).

All Swan prod­ucts uti­lize the Defined Risk Strat­e­gy (“DRS”), but may vary by asset class, reg­u­la­to­ry offer­ing type, etc. Accord­ing­ly, all Swan DRS prod­uct offer­ings will have dif­fer­ent per­for­mance results due to offer­ing dif­fer­ences and com­par­ing results among the Swan prod­ucts and com­pos­ites may be of lim­it­ed use. All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request. The S&P 500 Index is a mar­ket cap weight­ed index of 500 wide­ly held stocks often used as a proxy for the over­all U.S. equi­ty mar­ket. Index­es are unman­aged and have no fees or expens­es. An invest­ment can­not be made direct­ly in an index. Swan’s invest­ments may con­sist of secu­ri­ties which vary sig­nif­i­cant­ly from those in the bench­mark index­es list­ed above and per­for­mance cal­cu­la­tion meth­ods may not be entire­ly com­pa­ra­ble. Accord­ing­ly, com­par­ing results shown to those of such index­es may be of lim­it­ed use. The adviser’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advis­er invests or writes may prove to be incor­rect and may not pro­duce the desired results. There is no guar­an­tee any invest­ment or the DRS will meet its objec­tives. All invest­ments involve the risk of poten­tial invest­ment loss­es as well as the poten­tial for invest­ment gains. Pri­or per­for­mance is not a guar­an­tee of future results and there can be no assur­ance, and investors should not assume, that future per­for­mance will be com­pa­ra­ble to past per­for­mance. All invest­ment strate­gies have the poten­tial for prof­it or loss. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970–382-8901 or www.swanglobalinvestments.com319-SGI-080318

By |2018-10-02T10:50:20+00:00August 9th, 2018|Blog|Comments Off on The Times They Are A Changin’