- Changes to the widely used Global Industry Classification Standard (GICS) could create some short-term volatility in impacted sectors.
- The telecommunication services sector is being expanded to become the communication services sector and includes some stocks that had been in the information technology and consumer discretionary sectors.
- The communication services sector will likely be more cyclical and volatile relative to the broader market than the telecom sector, which had been more defensive and less sensitive to market moves.
- Communication services' dividend yields may be lower than telecom's, but investors can gain exposure to high-dividend-paying telecom companies either at the industry group or the individual stock level.
As of September 28, 2018, a number of notable changes are being made to one of the most widely used frameworks for classifying stocks, structuring market indexes, and reporting on portfolio performance and positioning. The updates to the Global Industry Classification Standard (GICS®) are some of the most notable since 1999 when it was launched by MSCI and S&P Dow Jones (S&P®).
After reviewing the GICS structure, MSCI and S&P decided to expand the telecommunication services (telecom) sector and rename it the communication services sector. The new sector will combine telecom companies with media and entertainment firms formerly classified in the consumer discretionary sector and internet companies formerly classified within the information technology sector. In addition, all remaining e-commerce companies (regardless of whether they hold inventory) will be moved from the information technology sector to the consumer discretionary sector. The changes to the sectors reflect how shifts in the ways that people communicate and access entertainment content have driven a broad integration of telecommunication, media, and internet companies.
Investors who use sectors for purposes such as reducing volatility or increasing yield will need to take the changed nature of the sectors involved into account and also consider new opportunities that may arise. Analyzing the long-term performance patterns of the legacy telecom sector and a proxy for the communication services sector relative to the broader market may help investors understand the implications of the changes. Since the global financial crisis, the relative performance of the communication services sector has been on a solid long-term uptrend, while telecom has steadily declined relative to the broader market. As the changes go into effect here are 4 things for sector investors to keep in mind:
1. A defensive sector has turned cyclical
Sectors are often categorized as either cyclical or defensive and the relative consistency of their performance over time enables investors to manage risk by tilting their portfolios toward cyclical or defensive sectors based on the current economic environment. Our analysis suggests that the new communication services sector is likely to be more cyclical than the telecom sector it replaces. Telecom was historically a defensive sector, but the performance of a proxy for the communication services since 2009 suggests it will be a more cyclical sector, likely to outperform when the economy is improving and more volatile relative to the broader market. Defensive sectors tend to outperform when economic growth is slowing and tend to exhibit less market sensitivity and lower overall volatility.
2. Dividend yields may be lower
Investors who seek income from their portfolios often include higher yielding sectors in their equity portfolios and telecom has historically been among the sectors with the highest dividend yield. However, yields will likely be diluted in the expanded communication services sector and investors may need to seek alternative sources of income from other sectors with relatively high dividend yields such as real estate, utilities, or consumer staples. Note that investors can still seek exposure to the benefits of telecom stocks (including their generally higher dividend yield and more defensive characteristics) at the industry group or individual stock level.
3. Stock picking opportunities may increase
When the dispersion of returns within a sector is high, a wide gap exists between the results of the best- and worst-performing stocks and when dispersion is low, the gap is narrow. Insightful active managers using fundamental analysis may be better able to pick winning stocks and avoid losing stocks when returns are widely dispersed. Over the past 3 years, the return dispersion among stocks that will be in the new communication services sector has been greater than in the telecom sector as measured by the standard deviation of returns. Therefore, the expansion of the communication services sector may open the door for opportunities for active stock picking.
4. Information technology and consumer discretionary are changing too
The information technology and consumer discretionary sectors will also experience changes as a result of the reclassification of companies and industries within the communication services sector. Many internet software and services companies and home entertainment companies will be moved out of information technology while media companies will shift out of consumer discretionary. Among the changes, 3 of 4 recent market-leading FANG stocks, including Facebook, Amazon, Netflix, and Google (Alphabet), are being reclassified within communication services.
Amazon, however, will remain within the consumer discretionary sector as part of the retailing industry group. Retailers will comprise nearly 66% of the consumer discretionary sector’s market capitalization within the S&P 500.
Despite the upcoming changes to the GICS framework, it is important to note that 8 of the 11 sectors will be unaffected. Moreover, the key benefits of a sector-based investing approach will remain intact. Investing in equity sectors enables investors to play an active role in managing their portfolios, gaining exposure to potentially attractive segments of the market or to certain investment themes. The new communication services sector will give investors exposure to the broad integration of telecommunications, media, and internet companies.
Next steps to consider
Match ideas with potential investments using our Stock Screener.
Access Fidelity's unique data and search capabilities.
Maximize the potential benefits of Fidelity's research tools.