Tweaks and GICS: themes and sectors’ shifting sands
The latest consultation on sector classification reaffirms our conviction that thematic strategies need to be built from the bottom up with active research, not solely based on top-down screens.
When is a financial service not a financial service? For a long time, the answer has apparently been: “When it’s a payment processor”.
Household names like Visa*, Mastercard*, and PayPal* are currently classified as technology companies under the Global Industry Classification Standard (GICS) system. That may change next year.
A new consultation from MSCI* and S&P Dow Jones Indices* is proposing to move such businesses out of the information technology sector and into the financials sector.
Such a switch would have important implications for tech investors given these three stocks’ size: each is among the top 10 positions in a typical tech-sector index.
Two points strike me about this. First, investors in traditional tech indices may not have realised how much exposure they had to credit cards. And second, investors in traditional financial-sector indices may not have realised that these important parts of the banking ecosystem were absent from their portfolios.
This is not the only proposal for consideration in the new GICS consultation. Another is that manufacturers of renewable energy equipment and renewable power systems, which currently sit in the information technology and industrials sectors respectively, shift into the energy sector.
While this clearly makes some intuitive sense, mixing fossil fuels with wind and solar in a single ‘energy’ index is likely to be problematic for investors who seek purer exposure to stocks driving and benefitting from the energy transition.
Creating logical indices with broad appeal is undoubtedly difficult. That is why we are not surprised to see more and more investors look at thematic strategies rather than sector-specific indices.
We must be careful that themes are not just sectors by another name, however. A key element in this is simply being more dynamic. If the planned GICS changes proceed, for example, they would be only the third such update since 1999 (following the creation of the real-estate sector from the financials sector in 2016 and the development of the communication-services sector in 2018, which extracted the likes of Netflix* from the consumer-discretionary sector and Facebook* from the technology sector).
Adopting an active, sector-agnostic approach to research when designing thematic strategies can result in more forward-looking exposures that are not constrained by outdated sector classifications and that often have very low overlap with mainstream indices. Working with industry experts can also enhance a bottom-up approach, through leveraging deep industry insights and unique data sets. And finally, we believe retaining the systematic nature of an index approach is key, as this can result in diversified exposure to a theme without taking too much company-specific risk.
Indeed, if these new GICS amendments go ahead, tech investors should have concentration risks very much on their mind. Apple* and Microsoft* already have high-double-digit weightings in many tech indices; if any of their fellow top 10 names depart for the financials sector, index managers will face an unpalatable choice between adding to this exposure (already bumping against UCITS limits) or inflating allocations to smaller stocks.
Equal-weight methodologies could be an answer here, and one that works well for growth themes where investors are seeking exposure to a new ecosystem or value chain as a whole rather than trying to pick winners.
We often say themes are tomorrow’s sectors. The latest GICS tweaks remind us that today’s sectors are often backwards-looking, relying as they must on past performance and historic perspectives on the economy. Well-designed themes can instead look to the future.
*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.