S&P, MSCI Shuffle Sector Lineups

Investment Insights S&P, MSCI Shuffle Sector Lineups Implications of Global Equity Sector Classification Changes

Stone Y. Cao Portfolio Strategy Associate

Highlights In 1999, global equity benchmark providers Standard & Poor’s (S&P) and MSCI Inc. jointly developed the Global Industry Classification Standard (GICS), a system for •• Within the Global Industry classifying publicly traded companies by economic sector Classification Standard (GICS), a new and sub-industry according to their principal business communication services sector will activity. Since then, the GICS has become the most widely go into effect in late September. followed classification standard in the industry, used globally by asset managers, brokers, custodians, consultants, •• The new sector includes the entirety research teams, and stock exchanges. However, the world today looks very different than it did in 1999, and S&P and of the current telecommunication MSCI conduct regular reviews to ensure that the GICS services sector and select companies remains relevant to the current business environment in from the consumer discretionary and order to best serve the network of financial professionals information technology sectors. and products that rely on it. •• Due largely to rebalancing of In November 2017, S&P and MSCI announced major changes to the GICS as a result of one such review. sector-specific ETFs, the reclassification Effective September 28, 2018, S&P and MSCI will could cause increased volatility for rename the telecommunication services sector as companies in all three affected sectors. communication services and expand it to include select companies from the current consumer discretionary and •• The impending changes will not information technology sectors (Exhibit 1). This change have a major impact on relative will be even larger than the carve out of real estate companies from the financials sector in 2016, which was sector positioning in Bessemer the first new headline sector addition since the creation equity mandates. of the GICS. It will impact companies worldwide across three different sectors with a combined estimated $4.3

Exhibit 1: Composition of the New GICS Communication Services Sector

Key Takeaway: New communication services sector will expand the existing telecommunication services sector to include select companies from information technology and consumer discretionary.

Telecommunication Services Information Technology Consumer Discretionary e.g. eBay, Telecommunication Services Software and Services Retailing Media Alibaba

e.g. AT&T, e.g. Alphabet, e.g. Netflix, Verizon Facebook Disney, Comcast

Telecommunication Services Media and Entertainment

Communication Services

Source: MSCI, S&P

September 18, 2018 Bessemer Trust Investment Insights S&P, MSCI Shuffle Sector Lineups

Exhibit 2: Top Companies Affected by GICS Changes, by Market Capitalization Top 15 Information Technology Top 15 Information Technology Top 15 Consumer Discretionary to Communications to Consumer Discretionary to Communications Market Value Market Value Market Value Name ($ billions) Name ($ billions) Name ($ billions) Alphabet 792.7 Alibaba 481.1 Walt Disney 168.8 Tencent 431.0 eBay 33.1 Comcast 163.6 Facebook 416.2 MercadoLibre 15.1 Netflix 146.9 Baidu 68.4 GrubHub 11.0 Naspers 108.6 Activision Blizzard 55.9 Delivery Hero 10.5 Twenty-First Century Fox 82.9 Nintendo 46.5 JUST EAT 7.1 Charter Communications 70.6 Electronic Arts 39.4 Rocket Internet 5.4 Sky plc 34.4 NetEase 33.9 Etsy 4.9 Vivendi 33.9 Spotify 32.9 Stamps.com 4.7 Sirius XM 31.5 Twitter 24.2 Takeaway.com 2.9 Liberty Media Formula One 25.2 Yahoo Japan 21.6 Baozun 2.8 Liberty Global 22.3 NAVER 21.1 Moneysupermarket.com 2.2 CBS Corporation 20.0 Take-Two Interactive Software 12.9 Shutterstock 1.6 WPP 19.7 NEXON 12.8 China Xingbang Industry Group 1.5 NeuroMama 18.9 Ubisoft Entertainment 12.6 Quotient Technology 1.4 Omnicom Group 15.4 As of July 31, 2018. Source: FactSet, MSCI, S&P trillion of market value (Exhibit 2). As the effective date content creators and content-delivery platforms, as well as draws closer, we expect media coverage to increase, the impact of the internet more broadly on the evolution of bringing heightened scrutiny and the potential for the business environment and consumer behavior. higher volatility in the affected companies and sectors in anticipation of the change. In this Investment Insights, The addition of the larger information technology we share our thoughts on the impending change, discuss and consumer discretionary companies (for brevity, the positioning of Bessemer’s equity mandates, and hereafter referred to as “technology” and “discretionary,” analyze potential market implications. respectively) will dwarf the legacy telecommunications companies, which will make up only 17% of the new S&P 500 communication services sector. Facebook and Google alone will make up roughly half of the new sector, Equity Benchmarks Reshuffled and current media companies within the discretionary The new communication services sector will include sector will make up over a quarter. Further, the newly companies such as Facebook, Netflix, and Google included companies will give the communication (Alphabet), which have been on the forefront of the internet services sector a more growth-oriented profile, a sharp age, changing how consumers access media content contrast to the more defensive, high-dividend companies and communicate with one another and reducing the that make up the telecommunications sector today. importance of traditional telecommunication mediums. The sector itself will balloon from roughly 2% of the More traditional content creators and distributors such S&P 500’s market capitalization to representing over as Disney, Comcast, and Twenty-First Century Fox will 10% of the index. Meanwhile, technology will decrease also be moved from the media industry within consumer from 25.6% to 20.1% of the index while discretionary discretionary into the communication services sector. In will decrease from 12.7% to 9.9%. addition, online marketplace and e-commerce companies such as Alibaba and eBay that target consumer goods and The effect on Bessemer’s global equity benchmark, the services will be aggregated into the consumer discretionary MSCI All Country World Investable Market Index, will not sector to join the likes of Amazon. S&P and MSCI believe be as pronounced, with the current telecommunications these changes appropriately capture the convergence of sector representing 2.5% of the index and the new

2 Bessemer Trust Investment Insights S&P, MSCI Shuffle Sector Lineups

Exhibit 3: Current Versus Projected Sector Weightings

Key Takeaway: Benchmark changes will not have a major impact on relative sector positioning for Bessemer’s All Equity mandate.

Current Sector Weightings Projected Sector Weightings 5 1 1 1 1 1 1 1 1 1 1

5 15 1

All uity MSCI ACW IMI SP 5 As of July 31, 2018. Source: Bessemer Trust, FactSet communications sector just over 8%. Technology will increase in exchange-traded funds (ETFs) tied to these decrease from 18.6% to 14.6%, and discretionary will sectors in recent years. As of July 31, sector-specific decrease from 12.4% to 10.7%. ETFs benchmarked to GICS-based indices that will be affected by these changes command around $74 billion of assets, nearly double the amount of assets managed Implications for Bessemer Portfolios three years ago (Exhibit 4). The majority of growth in these funds has occurred in the past two years. Bessemer’s All Equity mandate is currently overweight both Not included in this analysis are the also increasingly discretionary and technology by 2% and 3.7%, respectively, and underweight telecommunications by 1%. The expected Exhibit 4: Assets Under Management of Sector ETFs changes will not have a major impact on relative sector Directly Impacted by GICS Changes positioning, though we estimate telecommunications Key Takeaway: Sector-specific ETFs benchmarked to GICS-based exposure will grow from 1.5% of the portfolio to 6.6% indices affected by the announced changes represent nearly $74 billion in communications. Optically, the communications of investor assets, nearly double the amount managed three years ago. underweight increases marginally from 1% to 1.6% on an AUM of Directly Impacted Sector Funds ($B) absolute basis, but the mandate’s positioning will actually $ be closer to a neutral weighting when viewed relative to the benchmark. We estimate that exposure to the discretionary and technology sectors will fall to 13.9% and 17.6%, respectively, from 14.4% and 22.3%, and the overweight will $5 remain close to 3% for each sector (Exhibit 3). 1

$1 11 $1 Possible Near-Term Volatility for Affected Companies

While these sweeping sector changes have been well 1 201 1 201 1 201 1 2018 communicated by S&P and MSCI, it is possible that As of July 31, 2018. there will be volatility around the change given the Source: FactSet

September 18, 2018 3 S&P, MSCI Shuffle Sector Lineups

popular smart beta ETFs, which use rules-based short term volatility for the affected companies, though methodologies to select and weight stocks. This sector some ETF providers have already communicated and reshuffling may require some additional turnover from placed into effect plans to somewhat mitigate the impact. those smart beta funds that are sector constrained or sector neutral. Such funds make up an additional $40+ Vanguard, the world’s second-largest ETF provider, began billion of investor assets. transitioning its affected funds in May and is expected to finish by the end of the quarter. State Street Global Advisors Based on 13F filings for the directly impacted sector funds (SSGA) announced that it will not change its existing SPDR and our estimations of ex-ante benchmark weightings, S&P Telecom ETF (XTL) and instead launched another around $29.7 billion worth of securities, or 40% of these fund, the Communication Services Select Sector SPDR funds’ combined assets under management (AUM), will Fund (XLC), in June. SSGA also announced that it will go need to be bought or sold as a result of the reclassification forward with a standard rebalance at the end of September in order to rebalance to the new benchmarks. Over half of for its Technology and Consumer Discretionary Select Sector this turnover will occur in the 10 companies that we expect SPDR funds (XLK and XLY) to incorporate the benchmark to experience the heaviest trading activity (Exhibit 5). changes. To date, we have not seen any communication from Assuming zero net fund flows, we expect the companies the other ETF providers included in our analysis (iShares, remaining in the technology and discretionary sectors Fidelity, and Invesco) as to how they plan to manage the to be net beneficiaries of this exchange as the newly turnover within their sector offerings, so we expect that minted communication services companies are sold standard rebalancing procedures will apply for these funds. and the proceeds used to reweight the funds’ remaining constituents. Due to the smaller number and smaller AUM Longer term, if investors hold the impacted technology of the soon-to-be communication services sector ETFs, and discretionary funds as diversified vehicles to the new entrants will be a larger percentage of a much access the underlying internet and media companies, smaller pie and, as a result, should see net sales along with we may see assets flow out of these funds and into the legacy telecommunications names that will need to be communications sector funds, partially offsetting the sold in order to make space. This net buying and selling short-term trade flow from the rebalance. The new pressure due to rebalance activity may lead to higher sector will also provide another outlet for investors

Exhibit 5: Expected Turnover in Companies Likely to Experience Heaviest Trading Activity Key Takeaway: The ten companies with highest expected trading activity account for over half the total expected turnover. Estimated Absolute Trading Estimated Net Trade Name Current Sector New Sector Volume ($ millions) Flow ($ millions) Alphabet Information Technology Communication Services $4,524 ($4,022) Facebook Information Technology Communication Services $2,606 ($2,301) Amazon.com Consumer Discretionary Consumer Discretionary $1,679 $1,401 Microsoft Information Technology Information Technology $1,296 $1,264 Apple Information Technology Information Technology $1,203 $1,103 Walt Disney Consumer Discretionary Communication Services $942 ($843) Visa Information Technology Information Technology $934 $934 AT&T Telecommunication Services Communication Services $912 ($912) Comcast Consumer Discretionary Communication Services $902 ($809) Verizon Telecommunication Services Communication Services $886 ($886) Top 10 Combined Estimated Trade Volume $15,884 Total Rebalance Estimated Trade Volume $29,676

As of July 31, 2018. Source: Bessemer Trust, FactSet, MSCI, S&P

4 Bessemer Trust Investment Insights S&P, MSCI Shuffle Sector Lineups

seeking growth-oriented investments, potentially At Bessemer, portfolio management teams will continue weakening the technology sector’s hold on investor to monitor the impending changes and keep a close eye sentiment now that three of the five FAANG stocks on trading activity in the impacted sectors. The teams will be part of the communications sector. While continue to utilize a rigorous fundamental stock selection transitory, the expected heightened volatility may create process to find opportunities within each sector that opportunities for active managers that are tracking reflect our long-term investment philosophy. We remain these developments, particularly as managers comfortable with our relative sector positioning both re-evaluate their own sector positioning. before and after the projected change.

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