Money poured into the market’s newest sector this week, as a major reclassification moved some of the stock market’s hottest names into a new home.
On Monday, the communication services sector was introduced, making an immediate splash with a roster that includes three of the four FANG stocks – Facebook, Netflix and Google-parent Alphabet.
In the United States, exchange-traded funds tracking the new sector drew in well over US$1-billion on the week.
The popularity of index investing makes sector classification important for investors to watch, said Craig Jerusalim, a portfolio manager at CIBC Asset Management.
“Because there is so much passive money following these strategies, it’s going to have a bigger impact than it would have 10 years ago,” Mr. Jerusalim said.
The sector shuffle was introduced as a way to break up the U.S. information technology sector, which had become unusually large under the influence of several high-flying internet and tech names.
Companies plucked from technology and consumer discretionary sectors are now lumped in with telecoms under the banner of communication stocks.
The sector system of classifying companies is used by both S&P and MSCI to build indexes, which are then tracked by instruments like sector ETFs.
This week, investors flocked to two ETFs tailored to the new communication sector – State Street’s Communication Services Select Sector SPDR Fund and Vanguard’s Communication Services ETF. The two funds together have more than US$3-billion in assets under management.
Meanwhile, many U.S. ETFs targeting other sectors will have to sell names no longer included in the underlying sector index.
The index changes apply to the Canadian market as well, though with minimal weightings in technology and consumer discretionary, just a handful of stocks jumped sectors.
Joining the three publicly traded Canadian telecoms are four former consumer media stocks – Shaw Communications Inc., Quebecor Inc., Cogeco Communications Inc. and Cineplex Inc. Together, those stocks make up about a 5-per-cent weighting within the S&P/TSX Composite Index.
Telecoms still make up a big majority of the communication sector, meaning the sector doesn’t fundamentally change.
“The communication services sector will remain defensive, but slightly broader as the media companies get combined with the telecommunications companies,” Brian Belski, chief investment strategist at BMO Nesbitt Burns, said in a note. He rated the sector a “market perform.”
The U.S. communication sector, however, looks much different than its value-oriented telecom predecessor, with growth stocks Facebook and Alphabet accounting for about half of the sector weighting.
“However, even with these added stocks, sector valuations do not appear as lofty as some investors might expect,” Mr. Belski said, reiterating an “overweight” recommendation on U.S. communication.
Goldman Sachs strategist David Kostin also recommended that investors overweight the sector, which in its previous telecom incarnation was the worst performer after energy in the S&P 500 index since the start of 2010.
The transformed sector, meanwhile, would have actually outperformed the index over that same time, Mr. Kostin said. “The historical risk-adjusted return profile of communication services will be among the best in the S&P 500.”
No longer should the sector be considered a “bond proxy,” Mr. Kostin said. Previously yielding more than 5 per cent, the sector’s yield has now dropped to about 1 per cent.
“It’s a bit of a Frankenstein,” said Stephen Takacsy, chief investment officer at Montreal-based Lester Asset Management. “These stable, slow-growth, high-dividend-paying names are now mixed in with wildly volatile, overvalued, high-growth stocks. That will make it interesting for indexers.”