Big Changes in Store for the Biggest Financial Sector ETF

With nearly $16 billion in assets under management,

First There Were Changes to GICS On Nov. 10, 2014, index providers S&P Dow Jones Indices and MSCI announced the result of their annual review of the GICS structure. (GICS is an industry classification system jointly developed by the two firms, which was first introduced in 1999.) The most meaningful change springing forth from this review was the creation of a stand-alone real estate sector. According to the SPDJI and MSCI, this was largely driven by investor input. In the press release announcing real estate's graduation to sector status, Remy Briand, managing director and global head of equity research at MSCI, stated that, "Investors told us that there are significant differences between public real estate and financial companies and therefore real estate deserves a dedicated GICS sector." Thus, the eleventh GICS sector was born.

Then Came Two New SPDRs

On Sept. 2, 2015, SPDJI announced the launch of the Real Estate Select Sector and Financial Services Select Sector indexes. The benchmarks were licensed to State Street Global Advisors and now underlie the

But Now XLF's Bogy Is Changing On June 7, SPDJI issued a press release stating that the Financial Select Sector Index—XLF's current benchmark—will be dropping all real estate companies effective as of the close of business on September 16. XLF must now change, too. On June 8, SSgA issued its own press release outlining the mechanics of this transition.

A Special Kind of Special Dividend XLF will be shedding its current real estate holdings in the form of a special dividend. That special dividend will be paid to XLF shareholders in shares of XLRE, as well as a small cash residual which will solve for the fact that fractional shares in XLRE cannot be issued. The ex-date for XLF will be September 19. Buyers of XLF on that date will not be entitled to the special dividend. On September 19, XLF's share price will drop by an amount that will approximate the value of the special dividend. The record date for the dividend will be September 21 and the pay date September 22.

As September 16—the effective date for the changes to the Financial Select Sector Index—approaches, XLF’s real estate holdings will begin to be transferred on an in-kind basis to XLRE, thus creating new shares of XLRE. In an effort to mitigate the cost of implementation, SSgA has waived XLRE’s fee until September 16. In a June 22 webinar, SSgA estimated that—based on prevailing values at that time—this would result in the creation of $3 billion worth of new XLRE shares (the fund had $12.8 million in assets under management as of June 28). These XLRE shares will be held by XLF until they are ultimately paid out to XLF shareholders as a special dividend on September 22.

So Then What? Long-term investors that are glad to maintain the exposure they've obtained by investing in XLF should be largely indifferent to all of this, as the sum of XLRE and the new-look XLF's portfolios is identical to "old" XLF. SSgA had vetted other means of executing these changes and ultimately opted for this route given that the firm believes it will minimize market impact, as well as the costs borne by investors, and best allow fund shareholders to maintain seamless exposure to XLF (in its current form). To date, there isn't much detail available regarding the tax implications and/or treatment of this dividend. SSgA has promised to provide more information nearer to the September 19 ex-dividend date. As always, investors should consult a tax advisor to better understand the tax implications of this dividend.

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