The first reboot of S&P 500 Index group weights in almost two decades has arrived, shaking up stock portfolios and conjuring an industry out of real estate investment trusts (REITs) that will infuse at least one lightweight ETF with sudden riches.
With the push of a button, index overseers are breaking the stock market’s model of the financial industry in half, dividing REITs from banks and brokerages and giving them their own slot in the S&P 500. The biggest benchmarks will expand their tally of major industries to 11 from 10, reclassifying companies that have been among the bull market’s best performers.
While none of this changes the intrinsic value of any share of stock, the action matters for investors, particularly owners of exchange-traded funds tracking financial firms. Sponsors such as State Street Corp plan a hodgepodge of machinations to accommodate the division, another example of how much indexes matter to money managers as the industry evolves.
“It’s just a testament to this particular asset class and the performance there, basically affirming the fact that many of our clients believe there’s a place for this type of real estate strategy in a well-diversified portfolio,” said Ryan Sullivan, vice president of global ETF fund services at Brown Brothers Harriman. The New York-based finance firm has supported more than 25 sponsors in launching ETFs since 2004.
As an industry, real estate is among the least in need of PR burnishing, at least with ETF clients. With about $68bn in assets in funds tracking it, the group has more money invested in it than any of the other main industry classifications and has attracted the most cash since 2010, according to data compiled by Bloomberg.
“REITs as a group are already a big business with ETFs,” said Eric Balchunas, an analyst with Bloomberg Intelligence. “As a formality of moving it, I’m not sure how big of a deal it will be.”
REITs in the S&P 500 have rallied 360% since March 2009, buoyed by low interest rates that have weighed on banks and insurers. The return compares with a gain of 221% in the broader index. The group helped lift the financials industry that houses them to a rally of 294%, second among the 10 main S&P 500 sectors.
“As REITs have grown in importance from a corporate structure, their return streams have behaved very differently than the broader financials, which is really the reason why the index providers decided to make this change,” said head of State Street’s ETF and mutual fund research. “You’re going to have a new sector that is also very interest rate- sensitive, but in a different way than financials, really the opposite way, and now you’ll have the ability to play that in portfolios.”
The basics of reordering are a little geeky. Currently, the S&P 500, which serves as the benchmark gauge for American equity, is composed of 10 large industry groups, broad categories like energy, technology and utilities. Within those are 24 smaller collections that represent subsets of the bigger ones - refiners within energy, for example, or software within tech.
Buried inside the financial section of the S&P 500 are 28 REITs, the subjects of the current rearrangement.
With more than $580bn in market value, those stocks are already bigger than the telecommunications and mining sectors, and will become their own top-level industry.
As a result, any ETF sponsor that bases its offering on the S&P Dow Jones Indices and MSCI standards must take steps to align with the new makeup.
After Wednesday’s close, the overseers changed the Global Industry Classification Standard database designation of individual securities.
The adjustment will show up starting on Thursday for any index compiled by MSCI, while S&P Dow Jones indexes won’t reflect the changes until after the close of trading on September 16, as part of a quarterly index rebalancing, an S&P spokesman said.
State Street Corp is one of several ETF sponsors that must react to the actions. It has two securities that will be affected - the $16.2bn Financial Select Sector SPDR, or XLF, which it created in December 1998, and the much smaller Real Estate Select Sector, or XLRE, started in October. On September 16, the company will shift about $3bn from XLF to XLRE to rebalance the funds, reducing XLF’s assets to $13bn while raising XLRE from little more than $100mn, according to ETF.com.
The step will propel the 11-month old XLRE to the ranks of the five largest US real estate ETFs by assets, next to products from Vanguard and BlackRock. State Street itself has four others that track real estate.
“Certainly this is a means of growing XLRE,” Mazza said.
One thing the reshuffling isn’t spurring is the creation of a lot of new ETFs to reflect the classification. Many sponsors are waiting to see how investor preferences coalesce.
“Speed to market isn’t necessarily our game,” said Rich Powers, head of ETF product management at Vanguard Group, which has the largest real estate ETF, the $36bn fund that trades under VNQ. “Theoretically, there could be an advantage to being the first mover, but we’ve seen time and time again in the ETF and fund industry that it’s not necessarily the first firm to move but rather the quality product that ends up winning the day.”