How ETFs Could Look After Sector Changes

Later this year, Standard & Poor's and MSCI, two of the dominant providers of indexes for exchange-traded fund and index funds, will unveil changes to several major sectors as part of alterations to the Global Industry Classification Standards (GICS).

The telecom sector is expected to change in significant fashion as it will be renamed to communication services. That move is expected to impact not only telecom ETFs, but also consumer discretionary and technology funds because some companies currently classified as discretionary and technology stocks are expected to migrate over to the new communication services group.

Those changes are expected to affect scores of popular sector ETFs, including the Vanguard Telecom Services Index ETF VOX, Vanguard Consumer Discretionary ETF VCR and the Vanguard Information Technology ETF VGT.

How Issuers Could Deal With The Changes

“CFRA thinks Vanguard could choose to pay a special dividend to shareholders of VCR and VGT in the form of VOX as a tax-efficient way to distribute the shares of Disney and Alphabet and other such communications services stocks that would need to be removed from the firm's consumer discretionary and technology sector ETFs," CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth  said in a note out last week. "[U]nlike 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.”

Not A New Development

The idea of ETF-based special dividends as a way of dealing with sector changes isn't new. When real estate departed financial services, becoming the 11th S&P 500 sector, investors in the Financial Select Sector SPDR XLF received shares of the Real Estate Select Sector SPDR XLRE.

Similarly, Fidelity and iShares could follow a special dividend approach as they have Fidelity MSCI Telecommunications Index ETF FCOM and iShares Global Telecom ETF IXP, respectively, which own just telecom services stocks,” said Rosenbluth.

New Looks

Walt Disney Co DIS accounts for 4.8 percent of the Vanguard Consumer Discretionary ETF's weight, while Alphabet Inc GOOG and Facebook Inc FB, another stock that could depart the technology sector for communication services, combine for almost 17 percent of VGT's weight.

Adding those stocks to the communication services fray would bring a fresh look to ETFs like VOX. The Vanguard Telecommunication Services ETF currently allocates over 48 percent of its weight to just Verizon Communications Inc. VZ and AT&T Inc. T.

CFRA has Overweight ratings on VGT and VCR and a Marketweight rating on VOX.

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Disclosure: The author owns shares of XLF.