Commentaries
Major Sector Reclassifications Are Coming
The MSCI and the S&P Dow Jones Indices recently announced that they are consulting with the investment community on potentially changing their sector classifications. The consultation will end on February 18, 2022 and the final changes will be announced by March 2022. It is expected that the changes will be implemented by March 2023.1
The last sector reclassifications took place in 2018 and the most impactful change was moving Facebook and Google out of the Technology sector and into the newly created Communication Services sector. Had those changes not happened, the Technology sector would have an even bigger weighting in the S&P 500 than it does now. The most impactful changes proposed this time around would be in the Financials and Energy sectors, as the new classification would move payment processing companies from Technology to Financials and add renewable energy companies (currently in the Technology and Industrials sectors) to Energy.1
There will be immediate impact on the Financials sector after the reclassification. As of the close of business on December 10, 2021, Visa, Mastercard, and PayPal alone had a combined market cap of over $1 trillion. Along with other payment processing companies such as Fiserv, Global Payments, and Western Union, the reclassification would increase the Financials sector weighting in S&P 500 from the current 11 percent to 14 percent. More importantly, it will significantly change the characteristics of the Financials sector. The sector is currently dominated by stodgy money-center banks like J.P. Morgan and Bank of America with modest growth prospects. The addition of high-growth payment processing companies like Visa and PayPal will make the sector more growth-oriented and more exciting. With more payment processing companies coming into the public stock markets and their inherent high-growth nature, the Financials sector would become increasingly more pro-growth.
For the Energy sector, the change is all about the future. With currently less than three percent of the S&P 500 weighting and dominated by giant oil majors like Exxon Mobil and Chevron, the entire sector has been all but deserted by investors, especially ESG-minded new and young investors. Immediately after the reclassification, we expect a limited impact due to the current modest size of publicly traded renewable energy companies. As more and more private and new renewable energy companies come into the public stock markets, the Energy sector may become more and more relevant again. As renewable energy companies keep growing, the equivalent of a Tesla in the Energy sector may emerge in the near future.
The upcoming sector reclassification will potentially attract more investment inflows into the Financials and Energy sectors, partly due to the rising popularity of ETFs among investors. ETFs are all the rage these days and inflows into ETFs have already exceeded $1 trillion in the first eleven months of this year.2 Sector ETFs and thematic ETFs are particularly popular and the upcoming reclassification will make the Financials and Energy sectors more appealing to these ETF investors. From an ETF construction point of view, a good ETF should include companies with heterogenous characteristics so that it can provide significant diversification benefits. However, the current compositions of both the Financial and Energy sectors are quite homogenous in nature, one driven mostly by interest rates and the other by oil prices. The reclassification could potentially improve the diversification function of their sector ETFs quite significantly. From an investment theme perspective, the reclassification will instill popular and potentially secular investment themes such as fintech, renewable energy and ESG into thematic ETFs related to these sectors, further enhancing their appeal to investors.
Sources:
1. “CONSULTATION ON POTENTIAL CHANGES TO THE GLOBAL INDUSTRY CLASSIFICATION STANDARD (GICS®) STRUCTURE IN 2022,” S&P Dow Jones Indices, November 29, 2021, https://www.spglobal.com/spdji/en/governance/consultations/mr47787/
2. Michael Wursthorn, “ETF Inflows Top $1 Trillion for First Time,” The Wall Street Journal, December 12, 2021, https://www.wsj.com/articles/etf-inflows-top-1-trillion-for-first-time-11639257534
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