S&P Dow Jones Indices and MSCI are set to implement changes to the Global Industry Classification Standard (GICS) this month, modifications that will have an impact on S&P 500 ETFs as well as ETFs tracking specific sectors of the bellwether index.
Payment processing companies Visa and Mastercard are due to be reclassified from the information technology sector to the financials sector.
GICS represents a system for categorizing public companies by economic sector and industry group. The structure is widely used by a diverse range of market participants involved in the investment process.
Initially launched in 1999, GICS has evolved regularly over the years and currently comprises 11 sectors, 24 industry groups, 69 industries, and 158 sub-industries.
GICS’s periodic reviews are intended to ensure that the system remains reflective of current markets and continues to be an accurate and complete industry framework.
The index providers ran the latest consultation on potential GICS changes between December 2021 and February 2022. The dialogue revolved around seven areas although only three contained the potential to affect ETF investors – the reclassification of renewable energy companies, firms involved in data processing and outsourced services, and certain retailers.
Following the changes, which are due to be implemented after the close of business on Friday 17 March 2023, the GICS structure will consist of 11 sectors, 25 industry groups, 74 industries, and 163 sub-industries.
Renewable energy
The first proposition involved consolidating all types of energy producers, as well as related equipment and service providers, under the energy sector. Currently, many manufacturers of renewable energy equipment are classified under the information technology or industrial sectors.
Feedback from market participants was mixed with no clear consensus yet on how to reflect these changes in the GICS structure. The index providers noted, however, that it is likely that this topic will be revisited in future reviews.
Data processing
The second, and most significant, proposition was moving the data processing and outsourced services sub-industry from the information technology sector to the industrials sector. Some data processing and outsourced services companies, however, would be reclassified to the financials sector under a new transaction and payment processing services sub-industry.
Companies classified within the data processing and outsourced services sub-industry offer services either customized for select industries, such as human resources or travel, or to diverse industries as is the case with transaction and payment processing companies that connect consumers, financial institutions, merchants, governments, digital partners, businesses, and other organizations.
S&P DJI and MSCI proposed that these support activities are closely aligned with the business support activities covered under the industrials sector rather than the information technology sector, and with the financials sector in the case of payment processors.
Market participants agreed, supporting a reclassification that will see major information technology companies such as Visa, Mastercard, and PayPal switch to the financials sector, while other significant firms such as Automatic Data Processing, Paychex, and Financial National Information Services will migrate to the industrials sector.
The reclassification is expected to notably change the sector allocation of S&P 500 ETFs. For example, Exhibit 1 below compares S&P 500 sector weights at the end of 2022 under the existing GICS structure compared to the new structure, assuming it had already gone into effect. The weight of the information technology sector would have shrunk from 25.7% to 22.5%, while the weights of the financials and industrials sectors would have risen, from 11.7% to 14.4% and from 8.7% to 9.1%, respectively.
Source: S&P Dow Jones Indices.
The reclassification is also expected to generate a significant rebalance in related sector ETFs as well as shake up these sectors’ diversification profiles. Most notably, in terms of the information technology sector, the reclassification will enable current mid-cap stocks to play a greater role in driving overall performance.
Notable sector ETFs in the US include the $38.0bn Vanguard Information Technology ETF (VGT US), the $8.0bn Vanguard Financials ETF (VFH US), and the $3.1bn Vanguard Industrials ETF (VIS US), as well as the $36.3bn Technology Select Sector SPDR Fund (XLK US), the $27.4bn Financial Select Sector SPDR Fund (XLF US), and the $11.3bn Industrial Select Sector SPDR Fund (XLI US). All these ETFs come with expense ratios of 0.10%.
In Europe, notable ETFs include the $2.8bn iShares S&P 500 Information Technology Sector UCITS ETF (IITU LN), the $1.2bn iShares S&P 500 Financials Sector UCITS ETF (UIFS LN), and the $200m iShares S&P 500 Industrials Sector UCITS ETF (IUIS LN), all of which are priced at 0.15%.
Retailers
Another key, although less significant, update due to be implemented relates to the reclassification of retailers based on the nature of goods sold rather than according to the underlying technology used to deliver the product or service.
The index providers note that this update reflects retailers having increasingly taken an omnichannel approach to selling their products, reducing the demarcation between existing segments.
Retailers that generate a majority of revenue or earnings from staples such as food, household, and personal care products will be migrated from consumer discretionary to consumer staples. Notable firms impacted by this change include Target and Dollar General.
Based on S&P 500 sector weights at the end of 2022, the changes would have seen the consumer discretionary sector trimmed from 9.8% to 9.3% while the weight of consumer staples would have been bumped up from 7.2% to 7.7%.
Notable relevant sector ETFs in the US include the $4.2bn Vanguard Consumer Discretionary ETF (VCR US) and $6.1bn Vanguard Consumer Staples ETF (VDC US); as well as the $14.4bn Consumer Discretionary Select Sector SPDR Fund (XLY US) and $14.6bn Consumer Staples Select Sector SPDR Fund (XLP US).
In Europe, there is the $270m iShares S&P 500 Consumer Discretionary Sector UCITS ETF (IUCD LN) and $260m iShares S&P 500 Consumer Staples Sector UCITS ETF (IUCS LN).