Definitions matter, as ESG investors will surely be the first to tell you. And some of these could be due a change in a different, less closely watched, part of the funds universe.
MSCI and S&P Dow Jones Indices are currently consulting on potential changes to the industry classifications used in the indices they construct (and many passive funds follow). One notable idea under consideration would be to shift payment and transaction processing names such as Visa (US:V), Mastercard (US:MA) and PayPal (US:PYPL) from the information technology sector to financials.
Not exactly one to get the heart racing, is it? Yet it does matter when it comes to sector exchange traded funds (ETFs).
On the one hand, if the changes go ahead technology ETFs using MSCI or S&P indices will become even less diversified than they currently are. With names like Alphabet (US:GOOGL) and Amazon (US:AMZN) being shifted out of the information technology sector a few years ago, such funds already have a substantial skew to a couple of stocks.
To give an example, the iShares S&P 500 Information Technology Sector UCITS ETF (IITU) recently had 21.6 per cent of its assets in Apple (US:AAPL) and 19.8 per cent in Microsoft (US:MSFT), with similar allocations in global technology ETFs such as Xtrackers MSCI World Information Technology UCITS ETF (XDWT).
This latest change would make tech ETFs even more concentrated. As AJ Bell head of investment management Matt Brennan puts it: “Every time stocks are removed, it makes the technology sector more Apple-heavy.”
Financials ETFs, on the other hand, will become more diversified but perhaps less focused in the process. Nutmeg chief investment officer James McManus notes that Visa, Mastercard and PayPal would account for around a fifth of the financials sector market cap were they introduced at the time of writing. Their introduction would make financials ETFs less heavily weighted to banks, and arguably less cyclical.
For certain funds the ramifications could be huge. The FT reports that the proposals, due for implementation next year if approved, would spell a shake-up for some of the world’s biggest sector ETFs. Plenty of the major tech and financials UCITS ETFs available to UK investors would be affected too. But the wider effects might also be interesting.
Some specialists (such as Brennan) argue that sector funds are a purer play on market rotations than the likes of factor ETFs, and they certainly reward investors who get their calls right. But changes like this might lessen some of that appeal: financials ETFs should be less of a direct play on a value rally, while the technology funds appear to be less representative of their broader sector.
Importantly, this could be a positive for the thematics space. As Brennan notes: “It might play into the idea that themes are a better way to play longer-term growth trends, as these tend to cut across the sectors.” He gives the examples of the iShares Digitalisation UCITS ETF (DGIT), which recently had half its assets in the information technology sector and the balance in the communication and consumer discretionary sectors, among others.
I’ve spent plenty of time bemoaning thematic ETFs as blunt tools rife with hazards, and those criticisms remain. But as other funds evolve, perhaps there’s another reason to keep them in mind.
