Beyond these S&P 500 constituents, additional smaller-cap companies that could be impacted include Cincinnati Bell and World Wrestling Entertainment. More info can be found in the GICS consultation slides.

Sector Changes Could Be Coming For These S&P 500 Constituents

Stock Examples

Current GICS Sector

Future GICS Sector?

AT&T and Verizon Communications

Telecom Services

Communication Services

Facebook and Twitter

Information Technology

Communication Services

Disney and Netflix

Consumer Discretionary

Communication Services

GICS Consultation Document, July 11, 2017

Some look at passive sector ETFs in conjunction with active mutual fund alternatives, with a focus on relative performance success. However, CFRA believes the GICS changes highlight the importance of holdings-level analysis that we employ, since soon the three-year records of iShares, Vanguard, SSGA and other impacted sector ETFs would focus on the success of stocks no longer in the portfolios. While active technology-focused mutual fund managers can choose whether to own or sell Google, passive ETF managers need to follow index providers’ decisions.

In this piece, we offer a take on what this could mean for ETF investors, as S&P Dow Jones Indices and MSCI just started their related consultation. We expect changes to the GICS structure to be announced this year. As such, CFRA expects the aforementioned stocks and many others to remain constituents in their current sectors at least well into 2018.

Revamping GICSChanges to the GICS structure have occurred periodically in the past, most recently and prominently with the 2016 elevation of real estate. REITs were lifted out of the financials sector and formed a new 11th sector. At that time, GICS-related sector ETFs, such as the Financial Select Sector SPDR (XLF), exited positions in American Tower, Simon Property Group and other REITs. Investors wanting S&P 500 real estate exposure focused on the Real Estate Select Sector SPDR (XLRE).

However, CFRA thinks the potential impact of a new communications services sector would be more significant. The above stocks are widely held by GICS-based sector ETFs from the four largest ETF providers—iShares, Vanguard, SSGA and PowerShares—as well as Fidelity and Guggenheim. More significantly, some firms would need to make ETF constituent adjustments in three of their sector products, not just one as occurred with the real estate carve-out.

Affected SectorsStarting with the consumer discretionary sector, there is approximately $15 billion in diversified sector ETFs that CFRA thinks would be affected, though their exposure to the potentially impacted companies is distinct.

For example, the largest industry groups for the market-cap-weighted S&P 500 based Consumer Discretionary Select Sector SPDR (XLY) are media (24% of May assets) and internet and catalog retail (22%); the latter includes internet and direct marketing companies such as Expedia and Netflix, but also Amazon.

Based on CFRA’s initial review of the proposed changes, we think Amazon could stay in the consumer discretionary sector along with specialty retail companies (17%) and hotels, restaurants & leisure firms (14%). Comcast, Disney and Time Warner are among the largest holdings.

In contrast, the Guggenheim S&P 500 Equal Weight Consumer Discretionary (RCD) has more specialty retail (22% of assets) and less media (15%) exposure, despite holding the same S&P 500 constituents. However, RCD equally weights retailer Best Buy and Comcast despite the latter have a market cap 10 times the size of the former.

Vanguard also offers the Vanguard Consumer Discretionary Index (VCDAX) in a mutual fund wrapper, tracking the same MSCI index as VCR. The two are separate share classes within the same parent fund.

Tech, Telecom & Utilities

Shifting to the impact on technology ETFs, the largest and fifth-largest industry groups for the Technology Select Sector SPDR (XLK) are software (19% of May assets) and internet software and services (14%). XLK’s holdings in these industries include Electronic Arts, Facebook and Google, all of which CFRA thinks could be impacted by the proposed GICS changes.

While some U.S.-focused sector ETFs have combined telecom with another sector, the iShares Global Telecom ETF (IXP) tracks a global S&P index of only telecom companies. AT&T and Verizon are in the top 10 holdings, along with Canadian telco BCE and European carriers Deutsche Telekom and Vodafone Group. In addition, Fidelity and Vanguard each offer MSCI-based U.S.-focused telecom ETFs.

CFRA thinks the potential creation of a communication services GICS sector, bringing together companies currently in three different sectors, would have a large impact on the sector ETF universe. The above and other passively managed funds simply aim to replicate an S&P or MSCI based index.

These index trackers do not have discretion the way actively managed funds do, such the MFS Technology Fund (MTCAX), which has an 11% weighting in consumer discretionary stocks. We will keep an eye on these developments and provide updates on what they mean for investors.

At the time of writing, neither the author nor his firm held any of the securities mentioned. Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence's equity and fund business in October 2016. He can be reached at [email protected]. Follow him at @ToddCFRA.