09/21/16   Some Surprises for Financials and Real Estate ETFs

Editor’s Corner

Ron Rowland

Four weeks ago, I wrote about the imminent change to the Global Industry Classification Standard (“GICS”) that would pull most equity REITS out of the Financials sector and place them in a newly defined 11th sector. With Real Estate’s promotion to sector status, various indexes and exchange-traded funds (“ETFs”) would need to make adjustments.

The GICS change took place August 31, 2016, and most affected indexes did not implement the changes until after the market close on September 16. When markets opened for trading on Monday, September 19, there were a few surprises awaiting traders and owners of ETFs targeting the areas impacted by the GICS changes.

There are 37 U.S.-listed ETFs targeting the Financials sector and another 35 targeting securities now belonging to the Real Estate sector. My analysis shows that 18 of the 37 Financials ETFs are potentially affected by the GICS change, and not all are affected in the same manner. The 19 Financials sector ETFs that are not likely to be affected are those that have little or no exposure to REITs. For the most part, these are the more narrowly defined ETFs targeting banks, insurance, brokers, asset managers, and business development companies.

Shareholders of the largest ETF in this space, the Financial Select Sector SPDR (XLF), were among the first to receive an unwelcome surprise. XLF opened for trading on Monday at $19.35 after being valued at $23.62 as of Friday’s close. They regained their composure after learning the 18% drop was due to a special dividend consisting mostly of shares of Real Estate Select Sector SPDR (XLRE). However, shareholders received a second shock when they heard that only 70%–80% of this dividend would receive favorable return-of-capital tax treatment, while the remainder would be taxed as ordinary income.

Traders of the Guggenheim S&P 500 Equal Weight Financials ETF (RYF) received a surprise of a different sort Monday morning. It seems both the ETF’s trading price and its intraday indicative value (intraday net asset value) fluctuated between the pre-adjusted value of $44 and the post-adjusted value of $31 multiple times in pre-opening and the first hour of trading on Monday. Obviously, not all players were on the same page regarding Guggenheim’s plan for RYF shareholders to receive a special dividend of Guggenheim S&P 500 Equal Weight Real Estate ETF (EWRE) and for the price of RYF to be adjusted to reflect that dividend. As a result, all trades executed at a price of $34.01 or above were canceled, which resulted in about 1,200 trades for 650,000 shares being taken off the books.

Not all 18 of the potentially affected ETFs paid a dividend in shares of a corresponding real estate ETF like the above examples. Vanguard Financials ETF (VFH) has already performed an outright sale of its REIT holdings to align itself with the new GICS classification. Today, those shareholders no longer have any exposure to REITs. If they want to get back to the same sector allocation they had before the change, then they will need to sell about 20% of their VFH holdings and use the proceeds to buy Vanguard Real Estate (VNQ). The iShares U.S. Financials ETF (IYF) still has about a 22% allocation to REITS and appears to have no plans to change.

In a few weeks, you will start seeing the ETF asset flow reports for September, and the raw reports will show large inflows for Real Estate ETFs. However, you should view these reports with a skeptical eye, because there is likely to be equally large outflows for Financials ETFs. Analysts will need to make adjustments to isolate flows attributed to special dividends and portfolio mechanics from the flows resulting from actual net new additions.

The overall sector rankings look rather dismal, with eight categories now in the red, just two solidly in green, and one barely in positive territory. Technology strengthened over the past week andedgecharts-2016-09-21 improved its standing as the leading sector. Financials managed to hold on to its second-place ranking, but its loss of momentum left it far behind Technology. Health Care climbed three spots to third and edged into positive momentum territory in the process. Utilities was the big upside mover, vaulting from last place to fourth, but it stopped short of turning green. Consumer Discretionary was able to climb a notch to sixth, and Real Estate held steady in 10th. All other sectors experienced relative-strength declines. Energy took the biggest hit, dropping from third to eighth and moving to the red side of the momentum ledger in the process. Industrials and Consumer Staples both slipped a notch lower, while Telecom fell two spots to land on the bottom.

Micro-Cap is at the top for a third week, and Mid-Cap Growth becomes the first style category to lose its positive momentum in the current environment. The style rankings have displayed a clear preference for smaller-capitalization stocks for the past 11 weeks. Back on July 13, the three Small-Cap classifications plus Micro-Cap took over the top-four spots, pushing Mid-Cap Value, Large-Cap Value, and a couple others out of the way. Members of the small-capitalization foursome have occupied the top-two slots all 11 weeks and the top-four slots for eight of those weeks. Momentum scores for the leading group have been tightly bunch the past six weeks, but today there is evidence of dispersion. Interestingly, the four largest-capitalization segments are next in relative strength, and the three Mid-Cap classification are now on the bottom. Growth gained or overtook Value in all capitalization stratifications, with Large-Cap Growth posting a four-position improvement.

China has now completed five weeks at the top and is showing no signs of relinquishing that position. It has a 25-point margin over Emerging Markets and an even larger advantage over the other global categories. Japan held the #2 spot a week ago, but Emerging Markets moved a step higher and pushed Japan down a notch. Pacific ex-Japan was the big upside mover, surging from last to fourth with a small but meaningful 5-point boost in momentum. World Equity and the U.S. edged a notch higher, while EAFE and the Eurozone slid down the rankings. Three global categories barely slipped into the red, as Latin America, the U.K., and Canada were not able to post positive momentum readings. Latin America had the misfortune of falling four places lower, while the U.K. and Canada held their slides to one spot. Although they appear to be in a three-way tie for last place, Canada mathematically holds that dubious honor all to itself.



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.


Investors told us that there are significant differences between public real estate and financial companies and therefore real estate deserves a dedicated GICS sector.

Remy Briand, managing director and global head of equity research at MSCI


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