The biggest tech companies are about to undergo a major reshuffling on the stock market — here’s what’s coming, and why it matters

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MSCI and S&P are soon to make some changes to how tech companies are categorized on the S&P 500 for the first time since 1999.
On September 28, a new Communication Services sector will replace the current Telecoms sector, and will include some of the biggest stocks including Facebook and Netflix.
It's only the second sector addition since 1999, and is a recognition of how consolidation has melded the telecom, media, and internet industries together.
Exchange-traded funds that track S&P 500 sectors will be most affected by the reclassification, and some big providers are already making changes ahead of the implementation.

Some big changes are coming to the US stock market.

On September 28, S&P Dow Jones Indices and GICS will create a new sector for tech, media, and telecoms companies, and it's a change that will affect many of the the biggest and most popular stocks on the market.

Here's what you need to know.

What is happening?

S&P and MSCI are ditching the existing Telecoms sector and creating a new Communications Services sector. This new sector will include companies that provide platforms for communication, of course, and those that operate various kinds of media.

It will also fold in companies in the Consumer Discretionary Sector that are currently classified in the Media and Internet & Direct Marketing Retail sub-industries, and some companies in the existing Information Technology sector.

Communications Services will be the largest sector of the S&P 500 with about a 10% weighting, according to Wells Fargo.

Here's a detailed map of all the changes:

Screen Shot 2018 07 30 at 11.34.49 AM (1)

Why does it matter?

Apple is currently housed in the Technology sector, and in the Communications Equipment industry. These categories are determined by the Global Industry Classification Standard, or GICS, which is maintained by MSCI and S&P.

These boxes make sense for Apple, considering that the world's most valuable company still makes most of its money by selling iPhones. But over time, these categories have become more fluid for other tech companies. Is Verizon, with its recently acquired media arm Oath, really just a telecoms company? Is Facebook, now one of the world's largest distributors of news, a social network or a media company or both?

The new sector aims to address these questions.

The GICS is keeping up with how much evolution has taken place in tech. Facebook didn't even exist at the height of the tech bubble in 1999, the same year that MSCI and S&P first implemented the GICS.

And so, the GICS reclassification is a reminder of sorts to markets about what these companies really do, and it aims to reflect where companies earn most of their revenues from.

"The lines among media, communications, and content are blurred," David Blitzer, chairman of the index committee at S&P Dow Jones Indices, said. "It is time to acknowledge this convergence and the overlapping services these companies provide."

The most recent precedent for this kind of GICS reclassification also provides insight into why the 'right' sector grouping matters.

In September 2016, S&P and MSCI removed real estate companies and some real estate investment trusts (REITS) from Financials to create a new sector.

Real Estate, from its breakout as a sector through August 15, 2018, returned almost nothing — 0.5% — versus a 39% rally for Financials. This performance gap suggests investors focused on very different fundamentals for these once-unified sectors.

Which stocks are going to be affected?

The change is going to affect some of the biggest and most popular tech companies, including Facebook and Alphabet. Both will move from the old tech sector to the new communication services group. Also, their sub-industry will change from one called internet software & services to interactive media & services.

Netflix, another one of the so-called FANG stocks, is also getting reshuffled. It's going from the consumer discretionary sector, where it lives with companies like McDonald's and Ralph Lauren, to the new communication group. Disney and 21st Century Fox are making the same industry move.

"DVD rentals" is not the only thing that comes to mind when Netflix is mentioned these days. Big spending on original content and licenses is a key part of its business. So Netflix's sub-industry will change from Internet & Direct Marketing Retail to the more appropriate Movies & Entertainment category.

MSCI plans to release a final list of all the stocks affected before flipping the switches on September 28.

What does this mean for the stock market?

Exchange-traded funds designed to track specific industries will be affected.

Vanguard, the $5.1 trillion investor that essentially invented the equity index fund, announced in March that it was temporarily creating custom benchmarks for the Vanguard Consumer Discretionary Index Fund, the Vanguard Information Technology Index Fund, and the Vanguard Telecommunication Services Index Fund.

"These changes don't require any action from investors," Vanguard said in a statement, indicating that it's doing the heavy lifting behind the scenes.

BlackRock is overhauling its iShares Global Telecom ETF to become the iShares Global Comm Services ETF, and changing the kinds of companies it tracks accordingly.

"Longer-term, the 'less sexy' & somewhat 'forgotten' Telco names may gain mindshare & potentially garner more portfolio-manager interest/dollars as reclassification stirs a re-acquaintance," Chris Harvey, the head of US equity and quant strategy at Wells Fargo, said.

But unlike the Real Estate reclassification, most investors are no strangers to a good number companies being reshuffled, such as FANG stocks.

Wells Fargo estimates that the reclassification will affect about 10% of the S&P 500, and so investors need not do much on the drawing board. Some stocks are getting moved around, but their weights on the index are not, so the reshuffle itself may not be a big market mover.