- The S&P 500 Index is implementing major modifications
- The telecom sector will see a significant transformation
- Investors focusing on specific S&P 500 sectors may want to revisit their portfolios
There are changes afoot for the Standard & Poor’s 500 Stock Index (S&P 500). For those who closely track sector performance of the index and perhaps invest in sector funds, the changes are significant. For other investors, the impact may not be so noticeable.
While not cited as often in the media as the Dow Jones Industrial Average, the S&P 500 index is viewed within the investment industry as a proxy for the overall stock market. It is also a widely used benchmark to which investors often compare the performance of their equity portfolios.
Redefining the S&P 500 Index’s telecom sector
The biggest change to the index is the expansion of the telecom sector which will also get a new sector name. After September 28, 2018, the S&P 500 Index’s Telecommunication Services sector will be renamed the Communication Services sector. It will be comprised of the former telecom sector, as well as a broader range of technology, media and entertainment stocks.
The change is dramatic in that it is expected to be the largest sector change in the history of the S&P 500 Index.
Here are some facts about the new Communication Services sector:
- It will represent the third-largest sector in the S&P 500 Index based on market value
- Despite its size, it will have only 60 stocks, an indication that risks within the sector will be more concentrated
- It will re-shape the traditionally sleepy telecom sector to include more stocks with growth characteristics, such as Walt Disney, Netflix, Comcast, Facebook, Alphabet (the parent of Google), Twitter and Snap
- These changes will lower the overall debt level of the sector and will boost its operating margin as the newly-added companies have shown greater profitability
Implications of the new sector
In its new iteration, the Communication Services sector will no longer be a value-oriented sector emphasizing stocks that pay a high dividend yield. Its dividend yield is expected to fall from approximately 5% to closer to 2% when the changes take effect.
The new sector will include more growth-oriented stocks that benefit from positive market momentum but may be subject to greater price volatility. Investors should adjust their expectations of the new communications sector because it will no longer be seen as a “bond proxy” or one of the lower-risk higher yielding sectors in the S&P 500 Index.
This change will have a major impact on other sectors as well:
- The weighting of the Information Technology sector will be reduced from more than 25% of the S&P 500 Index to approximately 20%
- Traditional technology stocks (including some of the “high flyers” of the past few years) will now be spread across more than one sector, including the new Communication Services sector
- The weighting of the Consumer Discretionary sector will also be reduced as part of this change
What does this mean for investors?
While this change is significant for the index, the impact on investors may vary. An investor with stocks across the overall index will not experience any changes in stock exposure – only the sector classifications of the stocks will change. However, a sector investor’s positions may change dramatically. For example, those invested in an S&P 500 technology index fund would lose exposure to a significant number of major tech companies.
An investor with stocks across the S&P 500 Index will not experience changes, but the sector classifications of some stocks will change.
Changes like this are a reminder of the importance of maintaining broad and diversified exposure to the stock market, as well as regularly reviewing your portfolio with your advisor. Chances are we will see more changes to sector classifications going forward as the S&P 500 Index continues to evolve.