Introducing the Newest Sector: Real Estate | Charles Schwab

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Introducing the Newest Sector: Real Estate

August 22, 2016

Many people think of the stock market as a pie divided into slices, called sectors. For many years, a major classification system has divided the market into 10 sectors, but that’s about to change: Beginning September 1, real estate will become the 11th sector.

Why should investors care? Well, if you invest in sector-specific exchange-traded funds (ETFs), you may see some market volatility as ETF managers adjust their holdings to account for the fact that real estate will be migrating to its own sector. You may want to check your own portfolio allocation, as well, and rebalance if necessary.

Why are sectors changing?

Some background: Since its inception in 1999, the Global Industry Classification Standard (GICS®), published by Standard & Poor’s and MSCI, has divided all publicly traded companies into 10 sectors: consumer discretionary, consumer staples, energy, financials, health care, industrials, information technology, materials, telecommunication services and utilities.

Up to now, real estate has been part of the financials sector. But the two companies that developed GICS have announced they will spin off real estate into a separate sector in response to the growing importance of real estate in global equity markets. The number of companies won’t change—they’ll just be divided differently.

What will the new sector include?

The new real estate sector will mostly be made up of equity real estate investment trusts (REITs), with some real estate development companies included. Equity REITs own physical property—such as apartment buildings, office property or shopping malls—and typically receive rental income. (Mortgage REITs, which own mortgages instead of physical property, will remain in the financials sector.)

Equity REITs have done well in recent years. Low interest rates have allowed them to obtain cheap financing. At the same time, their relatively high dividend yields have attracted investors frustrated by low interest rates on other types of investments, such as bonds. REITs have also benefited from a recovering economy, while strong demand for apartments in the years after the housing market crash has led to higher apartment rents.

REITs face some challenges, however. If U.S. interest rates rise, it could make REITs less attractive. Apartment rent increases may slow as people grow more confident about the housing market. A trend toward online shopping could hurt traditional mall-based retailers, making it difficult for malls to demand higher rents from retail tenants.

How will ETFs react?

ETFs that aim to track the financials sector will have to remove REITs and real estate development company stocks from their portfolios. This selling could lead to higher fund volatility in the days surrounding the GICS change.

Meanwhile, ETFs forced to sell securities that have risen in value may generate capital gains, on which their shareholders will owe taxes. Usually, ETFs sell holdings only when their benchmarks change, which doesn’t happen very often—that’s one of the reasons ETFs typically offer shareholders a lower capital gains tax bill compared with mutual funds. Many investors don’t expect to pay much in capital gains tax unless they sell their ETF shares, so the higher tax bill may be an unwelcome surprise.

Finally, some investors may want to adjust their portfolio allocation to account for the change. If you hold a diversified mutual fund or a broad equity index ETF—one that tracks the S&P 500® index, for example—the fund manager will make the adjustment for you. However, if you hold sector-specific funds, you may want to take steps to adjust your exposure to real estate.

Diversification and rebalancing

Bottom line, if you’ve built a well-diversified portfolio, there’s not much urgency to react to the GICS change. However, given that markets are always evolving, it’s a good idea to rebalance your portfolio on a regular basis, to help keep it aligned with your risk tolerance and target allocation.

Important Disclosures:

Investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by visiting Schwab.com or calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Investment returns will fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost. Shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV).

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Risks of the REITs are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and credit worthiness of the issuer. 

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

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