MUCH ADO ABOUT NOTHING:
OR, WHY THE ADDITION OF COMMUNICATION SERVICES TO YOUR EXCHANGE-TRADED FUND PORTFOLIO IS NO CHANGE AT ALL
Did you ever wonder why similar companies like Comcast and Disney, owners of NBC and ESPN, are in different industries from other Communications firms, like AT&T and Facebook? We wondered that too. Wall Street, finally, has agreed to put all of these communication companies under one umbrella. For those of you that hold our Exchange-traded Fund strategies, we made that change in July. We added a Communication Services fund, reducing two other holdings, all months before the September 21st date that the industry changes.
Before this change by the industry, the firms listed below (and others) in three different sectors. A representative of the old Telecoms sector is the stalwart AT&T. Facebook was considered a technology company. Disney and Netflix, two Media service companies, were considered subsets of consumer discretionary. As Vanguard states, regarding the ongoing “Integration between telecommunications, media and internet companies…Companies now offer bundled services such as cable, internet services, and telephone services, making the service offerings difficult to delineate. (Vanguard 2018). Those and others stocks described above are now all combined into the newly created communication services sector.
If telecom was not in the portfolio before, then is this a new higher addition?
No. You may have noticed that we did not have a telecommunication holding in your ETF portfolios, and now we have about a 10% allocation to communications, dependent on your strategy. This does not indicate any more bullishness on the prior telecom firms. In the past, the old telecom sector was held at market weight tucked away in your technology fund. The new allocation represents more securities previously held in the Consumer Discretionary, technology funds, and the old telecom firms. A reduction of two of your funds accomplished reducing three sectors, in order to purchase the communication services fund.
Specifically, the old telecoms sector, with interest sensitive, indebted, mature firms, is gone. Companies in the new “communications services” sector, such as Disney and Facebook, have transformed this sector from a value sector into a growth and quality sector. A notable sign of this change is the old telecom sector, listed second from the left in the graph below; notice that it only holds value stocks, only Teal-colored. The bar on the far left, in contrast, is the newly combined communications sector, with the majority of its stock components listed as growth, in dark blue.
Briefly, what does growth, or quality, refer to? Two of the best indicators helping explain why we maintain your exposure to these firms are the stocks’ earnings and debt advantages. Again, compare the Teal to the Dark Blue Sectors, but in the graph below. The “new sector is expected to produce—a high level of earnings & sales growth… it will also have far less leverage…. 28% vs. its current…62% (State Street Global Advisor 2018). The earnings and sales of these firms are representative of growth firms. The lower debt of these firms is one of many characteristics of companies considered ‘quality’ – the desired characteristic this late in our business cycle.
So, why not trade on September 21st?
In the past, we had calculated that participating when changes occur can be to your detriment. As in the past, we made the changes early, in July. These distortions might or might not occur, but we aim to manage your portfolio with the least distortions and acted months before September 21st. More cautiously, we avoided some of the newer funds and instead chose Vanguard, a partner who is going beyond others in ensuring the stable transition within your funds over a period spanning almost half a year before the change.
Unlike Shakespeare’s book, for Lighthouse Financial, ensuring that your portfolio maintains our desired exposures is paramount to these changes, not a trivial matter. However, like Shakespeare’s book, our goal was to intentionally make this transition as impact-less as possible – in our outlook, in our exposure to the market, and for your potential to continue participating in this market.
Bartolini, Matthew J., and Anqi Dong. “GICS® Sector Structure Changes: What Do They Mean for Investors?” SPDR Spotlight. https://us.spdrs.com/docs-commentary/gics-sector-structure-changes.pdf