By Todd Rosenbluth, CFRA
The stocks in your sector ETF or mutual fund may be shifting this year, depending on which sector you invest in and which asset manager you work with. As is often the case with funds, what’s inside – not historical record — will be the driver of future returns.
Last week, S&P Dow Jones Indices and MSCI, the two index providers behind the widely-adopted GICS framework, provided more clarity on the soon-to-be renamed Communications Services sector, changing from Telecommunications Services. Currently, AT&T (T), CenturyLink (CTL) and Verizon Communications (VZ) are the three lone companies in the Telecom Services sector of the S&P 500. However, following the revisions to the GICS structure being implemented at the end of September 2018, the trio will be joined by some prominent stocks currently in the consumer discretionary and information technology sector.
Vanguard offers three relevant MSCI based sector ETFs/mutual portfolios, one for each of the consumer discretionary, technology and telecom services sectors. Vanguard Telecom Services Index ETF (VOX) and Vanguard Telecom Services Index; Admiral (VTCAX) hold CTL, T and VZ as well as other telecom services stocks such as Sprint (S) and T-Mobile US (TMUS), but these share classes do not hold any technology or consumer discretionary stocks.
CFRA thinks Vanguard could choose to pay a special dividend to shareholders of Vanguard Consumer Discretionary Index Fund (VCR) and Vanguard Information Technology (VGT) in the form of VOX as a tax-efficient way to distribute the shares of DIS, GOOGL and other such communications services stocks that would need to be removed from the firm’s consumer discretionary and technology sector ETFs; unlike actively managed funds that have discretion on timing of purchases and sales, index based funds automatically add and remove stocks once they enter or leave the chosen index.
Similarly, Fidelity and iShares could follow a special dividend approach as they have Fidelity MSCI Telecommunications Index (FCOM) and iShares Global Telecom (IXP), respectively, which own just telecom services stocks.
CFRA expects the constituents to change for Technology Select Sector SPDR (XLK) and Guggenheim S&P 500 Equal Weight Information Technology (RYT) at the end of September 2018. Both track an index being reconfigured and would no longer hold EA, FB or GOOGL. However, neither firm offers a standalone telecom services sector ETF. Rather, telecom stocks are smaller weightings in other sector-oriented ETFs.
Indeed, despite its name, SPDR S&P Telecom (XTL) has 60% in technology stocks, including Arista Networks (ANET) and Netgear (NTGR), communications equipment companies not being moved as part of the GICS changes. Meanwhile, Technology Select Sector SPDR (XLK) holds T, VZ and CTL, but approximately 90% of the assets are in S&P 500 technology stocks, including AAPL, FB, GOOGL and MSFT.
These pending changes to sector funds highlight the importance of understanding what’s inside a portfolio, not just the performance record. This is how CFRA rates ETFs and mutual funds, leveraging our stock research capabilities for our holdings-level analysis. Starting in October 2018, investors who choose ETFs based only on past performance will be “buying” invalid performance, since many of the underlying holdings will change to align with the new GICS roadmap. An investor who studies underlying holdings will be a better-informed investor. For investors who chase past performance, CFRA has a word of caution: Buyer beware.
Todd Rosenbluth is Director of ETF & Mutual Fund Research at CFRA.