As a reaction to the diverging drivers of many companies in today’s economy, the Global Industry Classification Standard (GICS) has implemented major changes to reclassify the official sector designation for many stocks. So what does this mean for investors?
Introducing the new communication services sector
The biggest change is the creation of a new sector called “communication services.” It is an attempt to recognize the realities of the modern economy, and it includes both the network and content providers, which in the past were separated across sectors. The networks (including internet, broadband, cellular and cable lines) can be thought of as pipes, while the content is the water that travels within those pipes (such as information, advertising, entertainment and social media).
To create this new sector, GICS is converting the old telecommunications services sector in its entirety to the communication services sector. In addition, a few companies from the information technology and consumer discretionary sectors will be moving into communication services as well. There will also be a small amount reshuffling from information technology to consumer discretionary. Highlights of these changes are shown below.
How the new sector was created
Source: Invesco, Alphabet Class A, Alphabet Class C, Facebook, Ebay, Netflix and Comcast represent 4.16%, 4.81%, 4.77%, 0.39%, 1.81% and 1.92% of Invesco QQQ as of Aug. 31, 2018.
What does this mean for investors?
It’s important to realize that while GICS is well-known throughout the industry, not all index providers use the classification scheme to define sectors. For example, S&P and MSCI indexes typically rely on GICS for sector classification, but Nasdaq and FTSE Russell indexes rely on the Industry Classification Benchmark (ICB) for their sector definitions. So depending on what classification the index follows, holdings may or may not change. Obviously, the most impacted funds will be those that track GICS-based indexes and have sector-specific exposure. Funds that track the technology and consumer discretionary GICS sectors will tend to get more concentrated and may have fewer underlying holdings.
The Invesco QQQ exchange-traded fund will not be impacted by this change for two reasons. First, since the fund tracks the Nasdaq-100 Index, the GICS classification plays no role in defining the universe of potential holdings. Additionally, Invesco QQQ invests across all sectors with the exception of financials and does not rely on a single sector such as information technology.
That being said, if investors use GICS as their lens to view the QQQ sector allocations, they will see a different sector allocation even though the holdings within the fund have not changed. The new allocations can be found below, and the result is that information technology will decrease from 59% to 43%, while consumer discretionary decreases from 23% to 17%. The new communication services sector is 22% larger than the original telecommunication services sector, making it the second-largest sector allocation within Invesco QQQ.
Before and after: QQQ GICS sector allocations
Sources: Bloomberg, L.P. and S&P Dow Jones, as of Aug. 31, 2018. “Other” includes health care, consumer staples and industrials.
It is no coincidence that recent innovators and disruptors have built their success by fully embracing technological advances afforded to them, such as digital, mobile and big data. Since innovative companies tend to adopt cutting-edge technologies early, they may appear similar at first glance, resulting in many investors lumping them together as “technology” companies.
In reality, the differences between these companies become starker after evaluating their business models and competitive advantages. For example, what has driven Apple to be the company it is today (premium hardware) is very different than what has resulted in the success of Amazon (low-cost, efficient retailer) or Facebook (advertising and social media). (12.65%, 11.05% and 4.77% of Invesco QQQ, respectively, as of Aug. 31, 2018)
Invesco QQQ provides exposure to innovative companies across sectors. Being sector-agnostic outside of financials has allowed Invesco QQQ to hold a company like Amazon, whereas many technology-specific funds may not. In my view, this feature will only be more pronounced going forward as many of the most innovative companies in our economy are being split across various sectors and away from technology.
Learn more about Invesco QQQ.
The Nasdaq-100 Index includes 100 of the largest domestic and international non-financial securities listed on the NASDAQ Stock Market based on market capitalization. An investment cannot be made into an index.
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There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. The Fund’s return may not match the return of the Underlying Index. The Fund is subject to certain other risks. Please see the current prospectus for more information regarding the risk associated with an investment in the Fund.
Investments focused in a particular sector, such as communications and information technology, are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.
Many products and services offered in technology-related industries are subject to rapid obsolescence, which may lower the value of the issuers.
The Invesco QQQ (QQQ) rose $1.49 (+0.80%) in premarket trading Monday. Year-to-date, QQQ has gained 19.47%, versus a 9.38% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Invesco.