For anyone who still thinks Apple is a technology company, its CEO has news. Tim Cook said in May that Apple isn't a tech firm — that it is in more the business of consumer products. Warren Buffett, whose Berkshire Hathaway invests in Apple on the back of its consumer identity, certainly thinks so, too. Yet of the roughly 240 stock indexes Apple is in, not one is consumer focused.
The problem is that the financial world's system of categorizing publicly traded businesses is broken. The most popular such system is the Global Industry Classification Standard, or GICS. Constructed by MSCI and Standard & Poor's, GICS determines what sector a company often falls into, directly or indirectly influencing trillions of dollars. GICS pigeonholes Apple as an information technology firm.
When it was developed in 1999, GICS was an improvement over the previously crude and mostly government systems, one of which imagines poultry processing as similar to tobacco. MSCI and S&P designed GICS with the financial researcher in mind and looked for similar sources of revenue. In those go-go days of tech stocks, investors flocked to a system that automatically separated an internet business from more mundane firms.
The global economy was simpler at the dawn of the internet age. But as the economy evolved, GICS has had to revise its sectors or subsectors nine times in 20 years.
The biggest revision came last September. GICS unveiled a new sector called communication services, which would house old-world telecommunications companies such as AT&T in one subsector, and in another, media firms that include Alphabet (Google) as well as Disney. Meanwhile, the "technology" sector will no longer house e-commerce companies, but will still range from semiconductors to data processors.
This latest revision only underscores that GICS has trouble keeping up with the pace of economic evolution. For one thing, labeling any company as "technology" no longer makes sense. Tech is so pervasive that even the most mundane bank or manufacturer today deploys a lot of software.
More importantly, companies today span multiple industries, particularly the internet platform companies that dominate popular discourse. Google, Amazon or Uber are interested in bringing consumers onto their platforms and using their scale to connect the consumers with another service or market. It almost doesn't matter what that other service is.
Should we define Amazon as an e-commerce firm, or as a cloud-services provider? Is Uber in the business of transport or food delivery? Perhaps Google and Facebook are today advertising agencies — they predominantly generate revenue from advertisers — though that may well change. Google is growing subscription fees from YouTube content, while some of its "moonshots" such as autonomous cars might someday land safely.
The faster the technological disruption, the more companies will consolidate — and further blur traditional lines. AT&T runs a telecom carrier, but conscious of the need to control both the pipes and the content going through them, it acquired media creator Time Warner.
The longer classifications stay broken, the more they distort capital flows. Many investors directly pour money into products linked to an index that MSCI, S&P and others construct along industry lines, thinking they're betting on an underlying industry or trend. The top 100 U.S. exchange-traded funds that track sector indexes totaled $472 billion in assets as of mid-June.
And indirectly, active fund managers are often benchmarking to indexes where companies are organized along GICS lines, with some $3 trillion benchmarked against MSCI's indexes alone. Even if they aren't benchmarking, analysts are constantly comparing one supposed consumer discretionary firm to another to answer growth, profitability, risk or valuation questions.
What should investors do instead? If they must classify, researchers could develop systems that don't involve industries. Barry Libert, Megan Beck and Yoram Wind, co-authors of "The Network Imperative: How to Survive and Grow in the Age of Digital Business Models," put firms into four buckets: those making physical things; offering services; creating intellectual property; and facilitating network transactions.
The best option then is for fundamental investors to reject the crutch that is classification and analyze businesses as idiosyncratic entities. For that, they have to roll up their sleeves and do real research.
Andrew Manton is the portfolio manager for the Shelton International Select Equity strategy. Abheek Bhattacharya is a research analyst on the international equities team, Greenwich, Conn. This content represents the views of the authors. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.
