What You Need to Know About the Major Tech Index Changes Coming Next Week

(Bloomberg) -- ETF investors have ridden tech stocks to outsized returns during the record bull market in U.S. equities. But a major shakeup coming next week to the indexes some of the biggest funds track could leave fans cheering for a team they barely recognize.

S&P Global Ratings and MSCI Inc., two of the world’s biggest index providers, are reorganizing their gauges by combining phone companies with some internet and media stocks into a new group called “communication services.” The shakeup will rip giants like Facebook Inc. and Google parent Alphabet Inc. out of many exchange-traded funds that track technology benchmarks.

“Tech is losing some of its biggest stars,” said Bloomberg Intelligence analyst Eric Balchunas. “It’s like the Golden State Warriors losing Kevin Durant and Steph Curry.”

The changes to the Global Industry Classification Standard Structure, better known as GICS, were announced in November and will be in effect at the market open on Monday. Investors need to be careful, however, because not all ETF issuers will respond in the same way to reflect the restructuring.

Different Approaches

Sectors funds run by Vanguard Group Inc. and State Street Corp., two of the three largest ETF issuers in the world, will have adjusted holdings to align with the GICS shuffling. Three Vanguard ETFs began tracking new transition benchmarks in May, aiming to reflect the eventual change, and State Street launched the Communication Services Select Sector SPDR Fund, or XLC, in response to the looming changes.

Investors traded more than $215 million worth of XLC on Thursday, an all-time record for the fund and more than eight times the average daily turnover since it started in June. One investor bought 1.1 million shares worth about $54 million.

On the flip side, the U.S. core sector suite for the iShares funds run by BlackRock Inc., the world’s largest ETF issuer, won’t be changing. That means that the iShares U.S. Technology ETF, or IYW, will maintain its hefty 18 percent combined exposure to Facebook and Google.

The point being, while sector holdings previously were pretty similar among issuers, the distinctions will now be stark. Investors may feel compelled to shift cash as differences in returns emerge, according to Daniel Prince, head of iShares product consulting.

“It’s a good time to take stock of what you own, because it will change, depending on what you hold,” Prince said. “The lion’s share of our client conversations has been focused on where the big tech names will be. I just got an email from one our salespersons for a financial adviser with the subject line ‘What ETFs will provide FANG exposure?’"

The iShares North American Tech ETF, or IGM, is the only market-cap weighted, broad-based technology index ETF that has FANG exposure, Prince said.

Invesco Ltd.’s S&P 500 equal-weighted sector funds will also get a makeover. For example, the Invesco S&P 500 Equal Weight Technology ETF, or RYT, will dump its 2.6 percent combined holdings in Facebook and Alphabet. The firm is seeking approval from the U.S. Securities and Exchange Commission for an equal-weighted S&P 500 communication services ETF, according to a regulatory filing.

Getting Ahead

Some investors have already started to shift their cash to maintain exposure to some of the big tech names. Through Thursday, buyers had poured $313.7 million into State Street’s XLC, the most since its launch.

Dave Haviland, managing partner of Beaumont Capital Management, helps run a quantitative sector rotation strategy at the Needham, Masachusetts-based wealth manager that primarily uses State Street’s SPDR sector funds. To get in front of the changes, he bought the communications services ETF in late June. And he doesn’t rule out more changes down the line as fund managers do or don’t adapt.

“That confusion and divergence of the different ETF manufacturers, or probably more the index providers, will probably cause some more change in the future,” Haviland said, also noting the attractiveness of the companies entering the new communications sector. “It doesn’t take a rocket scientist to know that indeed that sector is going to be desirable at times going forward.”

Still, investors should expect short-term volatility surrounding the rebalances, according to Peter Jankovskis, co-chief investment officer at Oakbrook Investments. His firm holds a number of the affected companies in their family of quantitative funds, which are scheduled to rebalance at the end of the month after the sectors realign. To him, the changes mean the tech sector as a whole could be spending less time in the limelight.

“People won’t be harping as much on technology as the market drivers as some of the leading names are being redistributed,” Jankovskis said. “It’s kind of overdue in terms of a realignment. Many of these names had been assigned to technology, because that’s where their roots are, but they really have more moved into the communications area. The reorganization makes a lot of sense.”

©2018 Bloomberg L.P.