Effective September 1, 2016, the Global Industry Classification Standard (GICS®) will undergo its first major change since its inception in 1999.
As a result of the evolving investment landscape, not to mention the global economy, real estate will be carved out of the financial sector. The new 11th sector will primarily contain equity REITs.
All Dow Jones and Russell indices will be unaffected by the change.
MSCI will make the change on Aug 31, but S&P 500 will change on Sept. 16, which is when most sector funds will rebalance.
The Break Up
The financial sector will be split into financials ex-real estate and real estate. After the change, we estimate that the S&P 500 will have a 14% weight in the “new” financials and 3.2% in real estate.
REITS and Real Estate Management & Development, which are currently sub-sectors under financials, will be renamed to form the new sector of “Equity REITS” composed of 28 companies in the S&P 500.
Mortgage REITs will remain within the financial sector given their greater similarity to traditional financial companies; however, they are a negligible percentage of the index.
From our calculations, specialized REITs (35%), retail REITs (22%), residential REITs (13%), and health care REITs (12%) will be the major components of the new real estate sector.
In making this change, we believe that both MSCI and S&P 500 recognize the increasing role of real estate in global equity markets and considerable growth in assets since 2009. In addition, the increasing specialization of real estate firms has made real estate the least correlated sub-group within financials.
Volatility: We expect that financials’ volatility will increase because the low correlation with REITs provided diversification.
Dividend Yield: REITs have a higher dividend yield (~3.5%) vs. 2.4% for the financial sector. So, taking out REITs will lower the dividend yield of financial ETFs to between 1.5-2%.
Performance: Financials ex-REITs will have a higher weighting of interest-rate sensitive sub-sectors such as banks, which will be negatively impacted by rate hikes.
Increased Demand: Most U.S. equity funds significantly underweight real estate, especially in value strategies. Based on a December 2015 JP Morgan report (1), there is pent-up demand of $100 billion for real estate funds, as long-only mutual funds have an average real estate underweight of 2.1%. Plus, new tax incentives for foreign investors in U.S. REITS may drive demand.
Outlook for Banks and Financial Stocks: Banks and financial stocks have more than recovered from the temporary sentiment-driven sell-off led by the Brexit uncertainty as well as concerns about the Fed’s policy stance. Yet financial stocks remain undervalued relative to other sectors, based on estimated P/E 2016, price/book and long-term debt/capital.
Unless economic conditions deteriorate significantly in the next few months, we expect a stable to steeper yield curve and higher rates by early 2017.
(1) J.P. Morgan Research, 17 December 2015, “2016 REIT Outlook: Remain Constructive as Growth/Valuation Stack Up Well and GICX Change Could be Boon; Risk is Rates.”
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