“The massive scope of this reclassification has the potential to disrupt portfolios if sector investors fail to prepare,” said SSgA in a recent note. “Portfolios that are not re-weighted could become overweight certain stocks while completely lacking some of the most well-known and profitable companies in the world. The result would be a complete mismatch of exposures that could introduce unexpected tracking error and risk into sector-related portfolios.”

Heavy Hitters

Since the communication services sector is not a new sector (it is a new take on telecommunications), XLC features exposure to traditional telecom companies such as Verizon Communications Inc. (NYSE: VZ) and AT&T Inc. (NYSE: T). However, the fund is heavily allocated to faster-growing companies.

For example, Google parent Alphabet Inc. (NASDAQ: GOOGL) and Facebook Inc. (NASDAQ: FB) combine for almost 43% of XLC’s weight. In other words, traditional technology ETFs will no longer be home to Alphabet and Facebook. Likewise, traditional consumer discretionary ETFs will see Netflix, Inc. (NASDAQ: NFLX) and Walt Disney Co. (NYSE: DIS), among others, depart to the communication services sector.

“While the result of rebalancing on sector exposure may not be astonishing, the effect beneath the surface is where this shake-up becomes interesting, especially when you look at it from a risk model or underlying holdings perspective,” said SSgA.

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