Overview
Early adaptors
Exchange-traded funds (ETFs) will be the first to adapt these changes to reflect the new benchmark configuration, and history suggests that actively managed funds will follow suit. The change will mean that asset allocators will no longer be buying tech ETFs to expose themselves to FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) and other Internet companies that enjoy structural growth.
The move puts an end to some traditional rules of thumb. The tech classification used to be a proxy for innovation, the consumer discretionary sector was about buying into consumer trends, and the telco sector harboured defensive and value stocks. The broadened communication sector is now a much healthier mix of growth and value names.
Source: Fidelity, Morningstar, as at 3 December, 2018. Characteristics are of the date given and should not be relied upon as current thereafter.
Rebalancing
Overall, the new classification may help to rebalance key indices and benchmarks. The old telco sector had shrunk to just 1.7 per cent of the S&P 500 while tech had ballooned to 26 per cent. Now, the communication services sector makes up 10 per cent of the S&P 500. The constituents of this new sector are the companies that have been able to monetise the most essential, and most quickly evolving, human need - communication. Perhaps the only constant within this industry is the perennial innovation and constant disruption thanks to technological innovation. The pace of this change has accelerated materially, which makes the sector perfect for active stock picking.
The communication services category contains a multitude of narratives. The internet segment, which represents around 40 to 50 per cent of the sector, consists of innovative, growing companies with a potential for high returns. Meanwhile, the telecom segment, which is a third of the sector, is viewed as containing defensive, value stocks which have historically struggled to generate returns above their cost of capital. They are providers of infrastructure, similar to utilities, while the internet companies can be expected to innovate and disrupt organisations in other industries. The media segment is a bit of both. Similarly, while the internet segment faces higher regulation, the telecom group will probably experience a broader de-regulation over time.
Unique combination
Any asset allocator that invested in a communication sector ETF over the last five years (had it been available) would have done very well, as the chart below shows, despite the telecom segment of the benchmark significantly underperforming the wider S&P index.
Source: Fidelity International, Standard & Poor’s, FactSet, Credit Suisse, 30 November 2018. Price return indexed to 100 on 31 December 2013. Communication Services represents the performance of the S&P 500 Communication Services Companies as defined by MSCI’s new methodology from 31 December 2013 to 30 November 2018. The performance is based on the constituents available in the index on every single day since 31 December 2013. If new communication services companies entered the S&P 500 index then such stocks were included in the analysis and if existing communication services companies exited the index then such stocks were thereby removed from the analysis. Old Telecom represents the performance of the S&P 500 Telecommunication Services Index from 31 December 2013 to 30 November 2018. The above chart is for illustrative purposes only.
But beyond the simple choice between ‘value’ or ‘growth’ oriented stocks, the benchmark offers a unique combination of sub-segments, which lends it to a thematic investing approach. Investors will be making decisions based not just on ‘value’ or ‘growth’; but on specific themes such as Internet regulation, the impact of streaming video, and cloud gaming. Communication services is a new name to get used to in the market, and there is a lot in it.
