The Index Updates Coming This March

MarketMinder Europe doesn’t make individual security recommendations. Specific companies mentioned here serve only to highlight a broader theme.

Last year, investment index providers S&P Dow Jones Indices and MSCI announced some changes to the Global Industry Classification Standard (GICS) structure, which is one of the most widely used methods of categorising stocks in terms of economic sector and industry, in our experience. With those updates taking effect this March, here is a look at what is getting recategorised—along with some titbits to keep in mind.

S&P and MSCI developed the 10-sector GICS system in 1999 to showcase certain economic sectors’ returns—especially then-white-hot Tech.^[i] The index providers review it annually and consult with market participants on potential changes to keep pace with the market’s fluidity, emergent economic sectors and industries, and individual companies’ evolution. In doing so, the GICS system aims to give a clearer view of the economy, though it isn’t always a perfect delineation, in our view, since companies may fall into some gray areas or overlap sectors. For example, GICS classifies a couple of big US Internet retailers under Consumer Discretionary—though we can see a case for them as Information Technology firms.^[ii] Our research shows there are also Tech firms that make the vast majority of revenue on consumer products and services.^[iii] Oh, and there is the little matter of the Energy sector containing no pure renewable energy companies.^[iv]

But we have found perfection is a pipedream in any endeavour, and we aren’t throwing stones. Rather, we think GICS is important to understand since many investors use the system for benchmarking (the practice of using an established index to guide portfolio construction) purposes, and its occasional shifts largely strike us as attempts to account for its quirks. That includes the addition of an 11^th sector—Real Estate—in 2016, before which it was an industry within Financials. Similarly, the Telecommunication Services sector got a makeover in 2018, morphing into Communication Services with the addition of several companies from Information Technology (Internet services) and Consumer Discretionary (media companies). The index providers relegated the less economically sensitive Telecom to an industry within the new sector, illustrating why we think changes are worth monitoring—if you are looking for a certain category of stocks, it helps to know where to look.

With the update coming this March, the new GICS structure will consist of 11 sectors, 25 industry groups, 74 industries and 163 sub-industries. Whilst there is no new sector this time, several industries are changing. Due to the evolving retail landscape, S&P and MSCI are getting rid of the Consumer Discretionary sector’s Internet & Direct Marketing sub-industry and grouping those businesses elsewhere based on the nature of goods sold. For example, online marketplaces Amazon and eBay will move to the Broadline Retail sub-industry of Consumer Discretionary whilst food delivery service Doordash will be in the Restaurants sub-industry.^[v] Digital pharmacy HealthWarehouse.com is moving to Consumer Staples’ Drug Retail sub-industry.^[vi] Beyond the consumer sectors, several Data Processing & Outsourced Services companies are moving sectors—for example, Transaction & Payment processing companies are shuffling from Information Technology to Financials.^[vii] Real Estate will have a bunch of new industries to help investors track specialisation, including eight new Industries (e.g., Industrial REITs [real estate investment trusts], Office REITs, Residential REITs, Hotel & Resort REITs, etc.).^[viii]

GICS updates aren’t market drivers, as they don’t affect the economic or political conditions that influence investor demand, in our view. Even after its move to the more economically sensitive Communication Services sector, the Telecom industry still generally behaves defensively—performing relatively well in market downturns and poorly in upturns, as demand for its goods and services doesn’t change much regardless of the economic cycle.^[ix] Reshuffles are also widely publicised when made—and take effect after a comment period—so they lack much surprise power, which moves stock prices most, according to our research. But we think GICS changes are worth being aware of from a portfolio construction standpoint. Take the decision to discontinue the Internet & Direct Marketing Retail sub-industry. We think the classification made sense earlier—some merchants were exclusively on the Internet whilst some big retailers (e.g., Department Stores) didn’t have as large an online presence. But as consumers’ preferences evolved, our research has found many retailers started blending brick-and-mortar and online channels—including outlets that started online. Thus, the change to Broadline Retail and discontinuation of Department Stores and Internet & Direct Marketing Retail—an update we don’t think is shocking to anyone who has visited a shopping centre recently. Yet if you wanted to get portfolio exposure to a certain type of retailer, it is worth being aware of these changes so you know where to look, in our view.

Or take payment processors, which have become ubiquitous at big and small shops alike. After starting in the Information Technology sector, they are now rotating over to Financials. We think the move makes sense given their core business is in payments and transactions. But it is also a reminder, in our view, many companies have characteristics spanning multiple industries or sectors. We think it behooves investors to do their homework and consider whether the company is an outlier within its category. Without doing due diligence, you may not be positioned in accordance with the conditions and trends you expect.