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Friday, May 1, 2015

What's a 'GICS', and Why Should We ETF -- or any -- Investors Care ?

The GICS Hierarchy
Because we should have some general idea what we're investing in, which is pretty much what the GICS -- Global Industry Classification Standard -- was designed to provide.

According to the Morgan Stanley Capital International [MSCI] website

  • In 1999, MSCI and Standard & Poor’s developed the Global Industry Classification Standard (GICS), seeking to offer an efficient investment tool to capture the breadth, depth and evolution of industry sectors.
  • GICS is a four-tiered, hierarchical industry classification system.
  • It consists of 10 sectors, 24 industry groups, 67 industries and 156 sub-industries.
  • Companies are classified quantitatively and qualitatively. Each company is assigned a single GICS classification at the sub-industry level according to its principal business activity. MSCI and Standard & Poor’s use revenues as a key factor in determining a firm’s principal business activity.
  • Earnings and market perception, however, are also recognized as important and relevant information for classification purposes, and are taken into account during the annual review process.

  • The 10 Sectors are :

    • Consumer Discretionary
    • Consumer Staples
    • Energy
    • Financials
    • Health Care
    • Industrials
    • Information Technology
    • Materials
    • Telecommunication Services
    • Utilities

    So... Leaving aside the fact that the nifty icon shows 68 industries, and MSCI cites 67... let's say we want to know what's classified as part of Financials (Sector 40).  Digging into the MSCI spreadsheet, we find, among the Financials Industry Groups, Insurance (4030) and Real Estate (4040), Drilling down we find among Real Estate's subindustries the category REITs, or Real Estate Investment Trusts (404020).

    Okay, so where am I going with this ? 

    Say, for some reason, you read Dave Dierking's SEEKING ALPHA post, "Preferred ETFs: 5-6% Yields, But What Are The Risks?".

    Observing that three such ETF's are heavily concentrated in Financials, some of which have less than Investment-grade credit ratings, the author concludes...
    Preferred stocks' reputation as lower risk investments is generally deserved as any examination of betas, standard deviations and price performance charts will attest to. But it's important to realize that many of these ETFs are riskier than most people realize when examining the credit quality of holdings and the content of the portfolio.
    The ETFs focused on in this article invest mainly in financials, but there are more diversified options out there like the Market Vectors Preferred Securities ex Financials ETF (NYSEARCA:PFXF), which is more diversified amongst utilities, defensive and industrial preferreds.
    Now one would infer from its name that Market Vectors Preferred Securities ex Financials wouldn't contain a single investment in that sector. But as Ron Rowland points out in his SEEKING ALPHA post,PFXF: New Market Vectors Preferred ETF Is 37% Financials"...
    Market Vectors Preferred Securities ex Financials ETF (NYSEARCA:PFXF), which launched on July 17, is designed to track the Wells Fargo Hybrid and Preferred Securities ex Financials Index (PFXF overview). Wells Fargo defines the Financials sector differently from the better-known GICS scheme. GICS considers Insurance and REITs to be part of the Financials sector. Wells Fargo and PFXF classify these two industries elsewhere. This creates the odd discrepancy of an ETF with “excluding Financials” in its name which holds 37% in the sector, based on the more popular GICS definition.
    According to the PFXF fact sheet (pdf), the underlying index consists of 68 securities with an average current yield of 6.8%. Industry breakdown includes REITs at 30.8%, Electric Utilities 26.3%, Auto Manufacturers 12.0%, Telecommunications 7.6%, Insurance 6.1%, and Energy 5.2%.
    Conclusion:  you can't just rely on the name of an ETF, or an investment firm's sticking to the GICS. Drill down into the ETF portfolio to see what it's made of, or you could be in for a rude surprise.