The shakeup, occuring later this year, will create a new major sector with more idiosyncratic risk
When plans to create a new “communications” category in the stock market’s Global Industry Classification Standard (GICS) made the news last year, some speculated on its potential impact, particularly on tech-focused ETFs. In a new analysis, investment bank Morgan Stanley has weighed in on exactly what the upcoming shakeup will mean.
“The realignment is unprecedented,” said the firm, as reported by MarketWatch. “Previously, the only sector change was the separation of real estate from financials in 2016, but this affected a smaller fraction of market cap, was simpler in terms of which stocks could go where, and had a longer lead time for investors to digest.”
The new classification, set to take effect in September, will see different communication-oriented companies that mostly span multiple sector categories re-boxed into one group. These include consumer discretionary stocks like Disney, Netflix, and Comcast, which have a combined market capitalization exceeding US$450 billion. Technology stocks like Facebook and Google parent Alphabet, which together have a US$1.3-trillion market cap, will also be moving over.
Morgan Stanley has found that the communications sector will be the third-largest based on market cap, accounting for 13.2% of the whole. But with only 60 components, the sector will be “mega cap-heavy and concentrated” in terms of holdings.
The prospective new sector “has higher stock-specific risk, meaning its typical stock is more idiosyncratic relative to standard equity risk factors, than the modified tech sector, and similar or higher stock specific risk to the modified discretionary sector,” Morgan Stanley said.
Speaking on the sector’s valuations, the firm said it will have a price-to-book ratio of 4.09, lagging both the revised technology (5.8) and consumer discretionary (6.39) sectors. It will also have the lowest dividend yield at 0.79%, compared to 1.6% for discretionary and 1.09% for technology. In terms of forward price-to-earnings ratios, the sector will have 22.53, as compared to 19.65 for the revised tech and 24 for the revised consumer sectors.
In a December note, Credit Suisse estimated that the new communications sector could affect 26 passive sector-tracking ETFs with over US$60 billion in assets, including 10 with over US$1 billion, as they are compelled to sell holdings that will be shuffled out of their benchmark indexes. While that could create short-term volatility in the affected stocks, MSCI and S&P Dow Jones’ plan to release a list of the largest impacted companies this August could give the market time to price in and possibly pre-empt shocks from such changes.
