Since inception almost two decades ago, the Global Industry Classification System (GICS) has been the standard taxonomy employed by the financial community to sort business entities by sector and industry group.
Changes to this taxonomy, no matter how small, can have a significant impact on how companies are classified and which enterprises are included in sector index and index products developed by Standard and Poor’s and MSCI. Understanding how these changes impact company and industry groupings is therefore critical for dividend investors.
In January 2018, S&P Dow Jones Indices, a division of S&P Global, introduced several revisions to the GICS structure. These changes, which will be implemented after the close of business on Sept. 28, 2018, impact three specific sectors:
- Telecommunications
- Consumer discretionary
- Information technology
The MSCI Equity Indexes will reflect these changes as part of its semi-annual index review in November 2018.
Proposed Changes
While changes to industry classifications may seem like a drastic measure, they reflect the natural evolution of businesses at the cross-section of information technology, communications and retail. The existing classification system, which was developed in 1999, is no longer sufficient to explain these important changes. The continued integration of telecommunications, media and internet has also led to broad industry consolidation through mergers and acquisitions.
Use the Dividend Screener to find high-quality dividend stocks. You can even screen stocks with DARS ratings above a certain threshold.
Telecommunications Services
Under the proposed changes, the telecommunications sector will be renamed communications services – a more inclusive banner that accounts for content developers and other media. The new sector will include existing telecommunications companies as well as enterprises from the media industry group, which currently falls under the consumer discretionary sector. This category will also include companies from the internet and direct marketing retail sub-industry along with some big companies currently classified in the information technology sector, including Alphabet Inc. (GOOG) and Facebook Inc (FB ).
Consumer Discretionary
The internet and direct marketing retail sub-industry, which is currently listed under consumer discretionary, will be updated to include all online marketplaces and e-commerce companies. Companies such as Alibaba Group (BABA ) and eBay Inc. (EBAY ) will fall under this category.
Check out what the investors are currently most interested in by visiting our Most Watched Stocks Page.
Information Technology
Finally, the information technology sector will undergo a major overhaul with the internet software and services industry being renamed internet services and infrastructure. Companies such as Shopify Inc. will be impacted. Cloud computing companies currently classified under internet software and services will receive a new category called application software. As a result, the internet software and services industry and sub-industry will be discontinued.
Sector Classification: Before and After
The previous sector weights and the new sector weights after the changes take effect are shown below.
| S&P 500 Index Sectors | Previous Weights (%) | New Weights (%) |
|---|---|---|
| *Consumer Discretionary* | *12.7* | *10.0* |
| Consumer Staples | 6.9 | 6.9 |
| Energy | 6.2 | 6.2 |
| Financials | 14.1 | 14.1 |
| Health Care | 14.5 | 14.5 |
| Industrials | 9.9 | 9.9 |
| *Information Technology* | *25.6* | *20.1* |
| Materials | 2.6 | 2.6 |
| Real Estate | 2.8 | 2.8 |
| Telecommunications Services | 1.9 | 0 |
| *Communication Services* | *0* | *10.2* |
| Utilities | 2.9 | 2.9 |
Taking all these into account, roughly 40% of the S&P 500’s entire market capitalization could be directly and indirectly impacted by the proposed changes. The three sectors most impacted by the changes – consumer discretionary, information technology and telecommunication services – have a total value of $17.6 trillion based on current prices. In terms of direct impact only, the GICS revision affects 10% of the S&P 500 Index market cap, 100% of the telecommunications services sector, 22% of the consumer discretionary sector and 21% of the sector technology sector.
The new GICS structure will be comprised of 11 sectors, 24 industry groups, 69 industries and 158 sub-industries.
Click here to learn about the GICS Industry structure.
How Do These Changes Affect Dividend Focused Investors?
The proposed changes have a direct impact on dividend-focused investors, particularly from the lens of telecommunications stocks. Historically, this sector was considered a bond proxy for its sensitivity to the U.S. 10-year Treasury yield. This sensitivity was reinforced by the sector’s high dividend yield, which averaged more than 5%. Under the new classification system, the communications services sector will yield an average of less than 2%. This means it will lose its bond proxy status and track more closely with the broader equities market
The S&P 500 Index has historically yielded an average of 1.89% going back to 2007. As the following chart illustrates, telecommunications services was the best-performing sector by a wide margin (by comparison, consumer discretionary and information technology yield well below the S&P 500 average):
| Sector | Average Dividend Yield (2007-2018) |
|---|---|
| Industrials | 2.02% |
| Consumer Discretionary | 1.28% |
| Information Technology | 1.18% |
| Consumer Staples | 3.13% |
| Materials | 2.09% |
| Energy | 2.66% |
| Real Estate | 3.38% |
| Financials | 1.83% |
| Telecommunications Services | 5.24% |
| Health Care | 1.64% |
| Utilities | 3.46% |
Nevertheless, the newly created sector may capture more growth exposure, which is not unlike the current telecommunications classification. For instance, according to the Morningstar Style Box classification, communication services will hold 61% of growth stocks, whereas consumer discretionary and information technology will have 64% and 47% allocation to growth stocks, respectively. All these sectors have higher growth allocation than the broader market.
The Bottom Line
The proposed changes to the GICS classification system impacts all investors with exposure to index funds. It is therefore prudent to get up to speed on the forthcoming update and adjust your portfolio accordingly.
Check out our Best Dividend Stocks page by going premium for free.
