Vanguard Seen Using Dividends to Handle Google's Tech Exit

(Bloomberg) -- Major ETF providers such as Vanguard Group Inc. and BlackRock Inc. could turn to an old strategy to deal with the planned sector shuffling by two of the world’s biggest index providers: paying special dividends.

S&P Global Inc. and MSCI Inc. last week announced one of the biggest overhauls of industry classifications in years, moving Facebook Inc. and Google’s parent Alphabet Inc. from the information technology group to the new communications category, which will replace telecom by merging existing phone companies with some Internet and media stocks. The plan’s biggest implications are for exchange-traded funds, where Credit Suisse Group AG estimated 26 of them with assets exceeding $60 billion may be forced to buy and sell shares to mimic the changes.

The solution for BlackRock and Vanguard, the two largest issuers of ETFs in the world, could be special dividends, according to Todd Rosenbluth, director of ETFs and mutual funds research at CFRA in New York.

Vanguard, which offers ETFs tracking the three affected industries, could choose to pay a special dividend to shareholders of the Vanguard Consumer Discretionary ETF and Vanguard Information Technology ETF in a form of the Vanguard Telecom Services ETF as “a tax-efficient way to distribute” shares of Google and other newly reclassified communications companies, Rosenbluth said. BlackRock and Fidelity could do the same, he said.

Such an approach is nothing new. When index providers rearranged bank and real estate stocks, ETF firms used a hodgepodge of strategies to maintain continuity for their customers, including special dividends that worked like spinoffs.

But it may not work for firms such as Guggenheim Partners and State Street Corp. that don’t have “a standalone” telecom ETF, Rosenbluth said. For example, State Street’s SPDR S&P Telecom ETF has 60 percent of its money invested in tech stocks, while the Technology Select Sector SPDR fund owns all three phone companies currently in the S&P 500 Index.

ETF overseers still have time to work out their transition plans. S&P and MSCI said changes aren’t scheduled to take effect until after the close of Sept. 28.

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