Last week, President Trump announced that, starting June 10, the U.S. would begin imposing a 5% tariff on all Mexico’s imported goods, in retaliation for a perceived influx of undocumented migrants across the southern U.S.-Mexico border.
It's the latest in a string of tariffs ordered by Trump, including an increase of import duties up to 25% on roughly $200 billion worth of Chinese goods in May. Trump further stated yesterday that he'd be willing to increase the scope of the Chinese tariffs by another $300 billion.
Setting aside whether or not tariffs are good trade policy, prolonged tariffs will have drastic impacts on the U.S. economy, as companies are forced to raise their prices to compensate for higher raw goods prices.
What's bad for the U.S. consumer could be good for ETF investors, however.
Assessing ‘Government Patronage’
TWAR, which tracks global large- and midcap firms, takes a two-pronged approach to stock selection: Not only does it evaluate companies on the strength of their intellectual property, using the firm's proprietary "Innovation α" methodology, it also assesses potential constituents on their ability to withstand a trade war.
To determine this, the advisor analyzes U.S. government and international trade data on state-sponsored enterprises, technology transfer agreements and joint ventures, thus assessing each stock's level of "government patronage."
The thesis is that companies with government contracts, subsidies and other benefits will tend to have more support in a protracted trade dispute, and will outperform their peers.
It is unclear whether that thesis holds true in practice, however. TWAR's top companies include General Electric (2%), Cisco Systems (2%) and IBM (1%)—two of which have underperformed the broader S&P 500 Index in the past month since the Chinese tariffs were increased to 25%:
Source: StockCharts.com; data as of June 5, 2019
(Use our stock finder tool to find an ETF’s allocation to a certain stock.)
TWAR vs PLCY
TWAR is designed to be a pure play on the trade war, as compared with the EventShares U.S. Policy Alpha ETF (PLCY), for which the trade war is just one of many possible investment themes.
PLCY, which now has roughly $18 million in assets under management, is an actively managed fund that takes long and short positions in about 100 or so companies impacted by U.S. government regulations, fiscal spending and trade policies.
Although trade negotiations and the NAFTA revamp are potential investable themes, according to recent company documentation, they aren't currently represented in the portfolio in any meaningful way.
That could change in future quarters, however.
Expensive Thematic Plays
Only time will tell whether the trade war as an investable theme can attract and hold investor interest.
However, both PLCY and TWAR are highly thematic plays and, like many such funds, carry hefty expense ratios. PLCY costs 0.86% per year to own, while TWAR costs 0.80%.
That, combined with sizable spreads, can result in a high cost of ownership for these ETFs for buy-and-hold investors.
However, given the ever-shifting nature of the trade war, these funds may be designed from the get-go to satisfy more thematic, tactical investors.
Contact Lara Crigger at [email protected]