New GICS Sector Could Benefit REITs

Posted by Chad LaFauci, CFA, CAIA

This entry was posted on Aug 24, 2016 10:30:00 AM

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GICSToday’s guest post is from Chad LaFauci, director of real assets at Commonwealth.

At the end of the month, the Global Industry Classification Standard (GICS) will introduce a new Real Estate sector—the first time a sector has been added since the system’s inception in 1999.

The real estate space has evolved significantly since then, and the change is intended to better reflect the unique characteristics of real estate investment trusts (REITs) and real estate management and development companies.

Let’s take a closer look at GICS and what this upcoming move could mean for investors.

What is GICS?

Created via a partnership between S&P Dow Jones and MSCI, GICS is an organizational structure for global equity investments, allowing investors to compare the performance of investments with similar characteristics, as well as overall portfolio allocations. It is also the main classification system used in the product development process.

What’s changing?

The GICS hierarchy currently includes 10 sectors, 24 industry groups, 67 industries, and 156 sub-industries. Real Estate has been classified as an industry group under the Financials sector, along with Banks, Diversified Financials, and Insurance. On August 31, Equity REITs and Real Estate Management and Development will become the underlying industry groups of the newly created Real Estate sector. (Mortgage REITs will remain in the Financials sector under a new industry classification.)

The estimated breakout of the total equity market will be as follows:

Sector Weight
Information Technology 20.63%
Health Care 14.11%
Financials 12.87%
Consumer Discretionary 12.80%
Consumer Staples 10.39%
Industrials 10.22%
Energy 6.94%
Utilities 3.43%
Real Estate 2.98%
Materials 2.86%
Telecommunication Services 2.77%

Source: CenterSquare Investment Management

What are the potential advantages?

REIT cheerleaders note that, once the change takes effect, generalist investors will be under-allocated to REITs, which may result in tens—if not hundreds—of billions of new capital flowing into the space. Of course, only time will tell if these optimistic expectations will play out.

What’s certain is that, once Real Estate is no longer hidden under Financials, the space will receive additional analyst coverage and investor attention.

In my eyes, though, the biggest potential positive is for REIT correlations to decouple from financials and the general market. From 2009 through the end of 2015, the FTSE NAREIT All Equity REITs Index exhibited a 0.74 correlation of weekly returns with the S&P 500 Index and a 0.78 correlation of weekly returns with the Dow Jones U.S. Financials Index. Historically, REITs have delivered very competitive long-term total returns. They also tend to exhibit income-focused returns, with a tax-advantaged structure and the potential to act as an inflation hedge.

If diversification benefits are enhanced as a result of this change, due to a lower correlation to the general markets, the long-term advantages of adding REITs to a well-balanced portfolio could increase. 

Real estate investments are subject to a high degree of risk because of general economic or local market conditions; changes in supply or demand; competing properties in an area; changes in interest rates; and changes in tax, real estate, environmental, or zoning laws and regulations. REIT units/shares fluctuate in value and may be redeemed for more or less than the original amount invested. There is no assurance that the investment objective will be attained.

The FTSE NAREIT All Equity REITs Index contains all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real 
property that also meet minimum size and liquidity criteria.

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