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 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 $68 billion 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 percent since March 2009, buoyed by low interest rates that have weighed on banks and insurers. The return compares with a gain of 221 percent in the broader index. The group helped lift the financials industry that houses them to a rally of 294 percent, second among the 10 main S&P 500 sectors. The shares were little changed as of 9:38 a.m. in New York.
“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 David Mazza, 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 $580 billion 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 Inc. 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 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 Sept. 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 $16.2 billion 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 Sept. 16, the company will shift about $3 billion from XLF to XLRE to rebalance the funds, reducing XLF’s assets to $13 billion while raising XLRE from little more than $100 million, according to ETF.com.
The step will propel the 11-month old XLRE to the ranks of the five largest U.S. real estate ETFs by assets, next to products from Vanguard and BlackRock Inc. State Street itself has four others that track real estate.