Meet The Sector Disruptors

Summary

• Equity sectors themselves have rarely changed, but the composition of companies within each sector evolves over time as we transition from one economic era to the next
• We believe that we are in the early stages of a period of significant disruption, given rapid advancements in technology and changing demographics and consumer preferences
• Rather than waiting for traditional sector funds to evolve to these new paradigms, investors can potentially pre-empt these changes by targeting Sector Disruptors: thematic ETFs investing in companies that are well-positioned to be a step ahead of the status quo by developing transformational technologies or catering to a rising consumer base

From the outside, equity sectors have been relatively consistent over time. While the economy evolves, Consumer Discretionary companies are always there to help us spend our disposable income. Energy firms are always there to fuel our vehicles to get us from point A to point B. In fact, in recent history, there has only been one major change to the Global Industry Classification Standard (GICS), which was to break out Real Estate as a distinct sector from Financials in 2016.¹ As we discussed in our CIO Insights: Sector Investing and Correlations, the constancy of sectors over time can be valuable to investors looking to manage macro-level risks and correlations.

Yet within each sector, change is unending. As powerful structural themes emerge, one era gives way to the next, and former sector bellwethers are often left behind. The desktop computer giants of the 1990's, like Dell and Compaq, were ultimately replaced by the mobile device makers and social media companies of the 2010's, like Apple and Facebook. This is part of natural economic Darwinism. Comparing major sector indexes to their compositions 18 years ago shows just how much sectors can organically change over time. The 2016 composition of the sector indexes referenced in the graph below bear little resemblance to their 1998 iterations, with each sharing nearly half or less in overlap to their older selves.

While turnover at the sector level occurs naturally over time, we believe we are in the early stages of a major period of sector-level disruption, given rapid advancements in technology and changing consumer preferences. Falling computing costs, the rise of artificial intelligence, and greater connectivity are dramatically changing how companies operate, and the products that they sell. Similarly powerful themes are stemming from changing consumer habits, as a new generation of spenders reach peak earning years, yet spend their money differently than generations before them. As a result of these emerging themes, the sector bellwethers of today look increasingly at risk of being replaced by companies positioning for the next paradigm.

While many investors may be looking to potentially benefit from these paradigm shifts, we believe traditional sector funds are ill-equipped to help investors do so. The traditional sectors tend to favor the winners of the past, tilting exposure to the firms that have already successfully capitalized on a specific economic paradigm. As the powerful macro-level themes mentioned above begin to accelerate, a new set of companies are likely to eventually rise to the top of each sector. Rather than waiting for traditional sector funds to cycle out of the old guard of companies in favor of new leaders, we believe investors can potentially pre-empt these changes by targeting Sector Disruptors: thematic ETFs that invest in companies that are well-positioned to be a step ahead of the status quo in developing revolutionary technologies or catering to a rising consumer base.

FOOTNOTES

1. MSCI, "S&P Down Jones Indices and MSCI announce Further Revisions to the Global Industry Classification Standard (GICS®) Structure in 2016," Nov 2, 2015.

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