ETF Expert Corner

iShares’ Chris Dhanraj Spotlights Evolved Sector ETFs

July 24th, 2018 by ETF Store Staff

Chris Dhanraj, Head of U.S. iShares Investment Strategy, recaps the upcoming GICS sector reclassifications and explains how iShares’ new suite of Evolved Sector ETFs seeks to stay ahead of the curve.



Transcript

You can listen to our interview with Chris Dhanraj by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: Last week, we went in-depth on this change to what's called the Global Industry Classification Standard that's set to take effect in late September, where the existing telecommunications sector is being broadened and a number of pretty prominent companies are being pulled out of consumer discretionary and information technology to comprise what will now be called communication services. Let's now bring in Chris Dhanraj, Head of US iShares Investment Strategy. Chris is joining us via phone from New York. Chris, great to have you on the program today.

Chris Dhanraj: Great to be here. Thank you.

Nate Geraci: Chris, we covered this in pretty good detail on our program last week, but for listeners who may have missed that, do you mind first just quickly recapping what's occurring here with these sector changes?

Chris Dhanraj: Absolutely. So, this fall, the telecom services sector will be expanded and broadened and renamed communication services. What that means is that this new communication services sector will bring in names from the consumer discretionary space currently, such as Netflix and Disney. They'll bring in some names from the technology sector currently, such as Facebook and Google. Your new communication services will include all of these names.

Nate Geraci: Now, because of this, there are a number of ETFs being impacted both by holdings moving out of existing sector ETFs and then obviously with the creation of ETFs in this new communication services sector. Are there any iShares traditional sector ETFs being impacted and, if so, how are you handling that?
Chris Dhanraj: Absolutely. So, most of our iShares products are going to be minimally impacted. The bulk of our sector ETFs do not follow the GICS methodology. There are a few industry and sub-industry funds that will be impacted such as our technology IXN ticker, consumer discretionary RXI and telecom IXP. But for the majority of our ETFs at iShares, because we do not follow on a large scale the GICS methodology, will have a minor impact. This applies to both US sectors and global sectors.

Nate Geraci: And for the few changes that are being made, are those going into effect right after the final changes in late September?
Chris Dhanraj: Yes, that's true. They will come into effect late September.

Nate Geraci: Alright, so let's talk about the iShares Evolved ETF lineup. These ETFs launched earlier this year - I might say perfect timing given these sector reclassifications because it really brings this issue of how companies are classified to the forefront. First, walk us through the lineup and perhaps explain the overarching idea here.

Chris Dhanraj: Yes, great. Come September, we will have this new broadened communication services sector. Ahead of that, iShares has launched seven Evolved sector classifications. We've launched IETC, which is technology. We've launched two healthcare-related Evolved sector ETFs. IEHS for healthcare staples, which is more defensive, and IEIH, which is innovative healthcare, more cyclically-oriented health care. We have financials Evolved sector, IEFN, as well as consumer staples, IECS. And then finally, we've broken up consumer discretionary in the traditional sense into two Evolved Sector ETFs, discretionary spending, IEDI, and media and entertainment, IEME. I think the reason why we have really focused on Evolved sectors as a new way to invest in sectors is really looking at the current model. Right now, under the current classification system, the methodologies to determine these classifications are backward-looking. They look at things like revenue, how a company has traditionally started out being classified. An example here is Amazon. Amazon started out as an online book seller and, as a result, it was classified as a consumer discretionary stock. But this ignores the company's moves in recent years into other industries. For example, the purchase of Whole Foods has now allowed it to have consumer staples exposure. It's done investments in health care. Its AWS platform for cloud is now technology. So the current system is very backward-looking. We have, at BlackRock, always prided ourselves on innovation and the Evolved sector really has forward looking input. We use data science techniques, for example, to analyze company filings - to see what a company is looking to invest in and is investing in, and allowing a better classification system to address that exposure.

Nate Geraci: Chris, how often are the individual holdings looked at to determine which sector they belong in?

Chris Dhanraj: So, our Evolved sectors will be rebalanced quarterly and that gives additional flexibility as companies evolve their business strategies.

Nate Geraci: As you touched on, these ETFs do use machine learning to determine which sector the companies belong in. Can you talk a little bit more about what's going on behind the scenes here?

Chris Dhanraj: Absolutely. So what we do here at BlackRock under our data science techniques, is apply machine learning and artificial intelligence to look at company filings. What we're doing here is really looking at how companies are describing themselves. How are they talking about their businesses? So, there's much less of a marketing spin on how the companies are viewed. How companies describe themselves in these regulatory filings is often the most factual way, and analyzing the text of these filings allows us to better classify these companies into the industries that they are participating in.

Jason Lank: Chris, this is Jason Lank. On that subject of using how companies describe themselves, can the system be gamed in any way? Can a company change how it names itself? For example, it's brewing iced tea this week and next week it's in the blockchain business. Is there a fail-safe or is there a mechanism to filter out, perhaps, some of the noise that companies may put out?

Chris Dhanraj: Great question, and the reason why we're really focusing on the regulatory filings. Usually in regulatory filings, companies play much safer. They are not going to address anything that isn't a part of their core business strategy. So we really focus on the regulatory filings and the company filings to make sure we're getting an accurate representation of how companies are positioning themselves.

Nate Geraci: Chris, if we were to sort of boil this down, is the idea with these ETFs to try and provide as pure of exposure as possible to a particular sector? Is that ultimately the goal here?

Chris Dhanraj: I think that's the idea. Really, what we're trying to do is provide the most intuitive exposure. Come September, for example, technology names will be spread across three sectors after this GICS reclassification. We're going to have Google and Facebook in communication services, this new sector we're talking about here. We're going to have Apple and Microsoft in technology. We're going to have Amazon in consumer discretionary. So an investor who's really trying to get the intuitive tech exposure can look at our Evolved sector ETF for technology, IETC, and get all of these names. An example here of why this matters, practically speaking, is if you look at technology as a sector in the past month, it was up about half a percent. If you look at our Evolved sector ETF, it was up 1.9% and precisely because our Evolved sector ETF, IETC, contains Amazon.

Jason Lank: Chris, on this subject, one of the parts of the process that I find really intriguing is that a company can be in different sectors, if my understanding is correct. Walk me through how that might happen. For example, you mentioned Amazon is in so many different places right now in the world. Is it appropriate to have them in one sector only or do you really put them where they belong?

Chris Dhanraj: So, I think putting them in different sectors addresses the reality that companies are investing across the spectrum. This gives you a more nuanced view about a company looking at different product lines. For example, looking at the Amazon example, Amazon - according to the Evolved sector technology classification - is 64% in technology and 36% in discretionary spending. This, in our view, actually describes the business model that Amazon has.

Nate Geraci: Again, we're visiting with Chris Dhanraj, Head of U.S. iShares Investment Strategy. We're looking at the iShares Evolved Sector ETFs. Chris, there are currently seven Evolved ETFs, but I believe you have 12 evolved sector classifications. Might we expect some additional ETF launches at some point?

Chris Dhanraj: So right now, we are always looking at ways that we can offer innovation differentiation, as well as addressing client demand. These seven ETFs are the areas that we are focusing on now. We're always looking at new areas of innovation, but these offer the most differentiation, these seven sectors or Evolved sectors, versus the current offerings under the GICS classification.

Nate Geraci: Chris, we have a few minutes left here. We are talking sectors, of course, today. I'm just curious, given the upcoming reclassifications and just given the market environment as a whole, have you seen anything noteworthy in terms of sector flows so far this year?

Chris Dhanraj: We have and actually, year-to-date, the tech sector has taken the lion's share of single sector exchange traded product flows. $14.3 billion have been coming into the sector. And I think what's really interesting, given the high rate of inflows into technology, is that most of those investors who are buying technology are not getting what I think people would traditionally classify as a tech stock, such as Amazon. So you're buying technology without Amazon and I think this is something where the Evolved sector approach, IETC for Technology Evolved Sectors, gives you that intuitive exposure. What you expect to buy is what you're getting in the Evolved Sector ETF.

Nate Geraci: Well, Chris, with that, we'll have to leave it there. Really interesting concept with these Evolved ETFs. We certainly appreciate your time today. Thank you.

Chris Dhanraj: Great to be here.

Nate Geraci: That was Chris Dhanraj, Head of U.S. iShares Investment Strategy. You can learn more about the Evolved Sector ETFs by visiting ishares.com.