08/24/16   Real Estate Promoted to Sector Status

Editor’s Corner

Ron Rowland

The Global Industry Classification Standard (“GICS”) system is implementing a significant change over the coming weeks. GICS was jointly developed by Standard & Poor’s and MSCI and is the primary system used by institutional investors to categorize stocks into their respective industries and sectors. The big change is the addition of Real Estate as the 11th sector¬.

Real estate investment trusts (“REITs”) are already included in the GICS system, but they currently reside within the Financials sector. After the change, most REITs will belong to the new Real Estate sector classification. The primary exception to this are the mortgage REITs. Mortgage REITs, as the name implies, are companies that invest in real estate mortgages instead of buying actual properties. That makes them similar to a lender, and therefore they will continue to be part of the Financials sector.

These classification changes will take effect on August 31, 2016. However, most of the affected indexes will not implement the change until September 16, and ETFs tracking the changed indexes all have their own timetables.

What will happen to the financial services ETFs in your portfolio? The answer is, “it depends.” Pay attention to your brokerage statements and notifications from ETF sponsors for possible clues. However, you may need to go to the sponsor’s website to get the full details. Today, some websites have little or no information available, and some prospectus updates only say that change is coming. Hopefully, this will improve over the next few weeks.

Vanguard plans to shift about a quarter of the assets, those representing REITs, from the Vanguard Financials ETF (VFH) to the Vanguard Real Estate ETF (VNQ) at the next quarterly rebalancing. At that time, VFH will no longer provide any exposure to REITs for its shareholders. VFH shareholders wanting to get back to their prior allocations will need to sell about a fourth of their VFH holdings and redeploy the proceeds into VNQ.

Guggenheim and State Street SPDRs are making the transition much easier for investors. Instead of placing the reallocation burden on shareholders, owners of the popular Financial Select Sector SPDR (XLF) and the Guggenheim S&P 500 Equal Weight Financials ETF (RYF) will receive special distributions consisting of shares in their respective real estate ETFs. XLF owners will receive shares of the Real Estate Select Sector SPDR (XLRE), and RYF owners will get shares of Guggenheim S&P 500 Equal Weight Real Estate ETF (EWRE).

Some market observers are claiming these changes will spark a lot of buying in REITs. However, I’m going to take the other side of that argument. In theory, these index and ETF changes should not generate any net buying of REITs. The quantity and allocation of REITs within the S&P 500 is not changing. Therefore, all of the REITs being purchased by various real estate index funds should be equal to the REITs being sold by the financial services funds. Yes, the REITs will end up in different places (funds), but the GICS change will not be creating any more REITs.

We’ve already made the changes in our rankings. In fact, our weekly sector rankings that appear here each week broke out Real Estate as its own sector in January 2013. However, since there has not been an ETF targeting the Financials sector without REITs, our Financials benchmark, the Vanguard Financials ETF (VFH), has included REITs. After Vanguard implements the GICS changes, there should be less correlation between our Financials and Real Estate benchmarks.

Sectors
Technology keeps its leadership role, while another sector slips into the red. This is Technology’s third week atop the sector rankings, and while it appears to have a firm grip on that position, its edgecharts-2016-08-24margin of leadership is shrinking. Energy moved two places higher to take over the second-place spot. Energy’s earlier rally attempt encountered a setback in July, but oil prices are moving higher once again and pulling stocks along for the ride. Materials and Industrials increased their momentum score, although they were both pushed a notch lower by the rise of Energy. Not much has changed in the middle tier, as these groups try to weather the summer doldrums. Telecom flipped from green to red, supplanting Utilities in last place and becoming the second category to register negative momentum. Yield is out of favor for now, with the four highest-yielding sectors sitting on the bottom of the sector rankings. Our factor rankings (not shown) confirm this with Yield now the lowest-ranked factor and Beta the top factor.

Styles
Relative strength across the style rankings is currently a function of inverse market capitalization. This outcome is an indication that the size factor is currently at work, where size means small size. The four smallest-capitalization segments are on top, the four largest are on the bottom, leaving the three middle-sized ones right in the middle. Changes over the past week were minimal. Mid-Cap Growth and Mid-Cap Value swapped places while remaining separated by only one momentum point. Large-Cap Value lost momentum but still managed to climb three places off the bottom. Large-Cap Blend also moved higher, pushing Large-Cap Growth and Mega-Cap each two places lower, with Mega-Cap now on the bottom.

Global
China completed its climb up the rankings and now sits at the top. Latin America, which has dominated the global rankings for most of the year, didn’t go very far and is solidly in second place. Momentum scores start to decline rapidly below these two leaders, although Emerging Markets is trying to bridge the gap in third. Canada and Japan each moved a spot higher, but it wasn’t due to their own strength. Instead, it was the result of weakness in Pacific ex-Japan, which slid two places lower to sixth. World Equity held steady, but there was some shifting among the lower-ranked global categories. EAFE and the U.S. climbed a notch higher as the Eurozone fell two spots. The U.K. remains on the bottom and has been struggling ever since the surprising Brexit vote.

 

Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

 


“It is a proper recognition that the public real estate arena is large enough and distinguished enough from Financials to be staked to its own Sector.”

Michael Knott, director of U.S. REIT research, Green Street Advisors


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