Index funds have become a popular, low-cost way to pursue opportunities in the stock market. The best-known index funds focus on the broad U.S. stock market and the companies in the Standard & Poor’s 500 Stock Index (“S&P 500 Index.”)
Not every investor may realize how diverse the options offered by index funds are today. Investors can participate in trends or focus on categories of companies that have the potential to deliver even stronger returns than the broad market. Following are examples of some of the opportunities investors can capture by looking beyond the ETFs that simply replicate the S&P 500 Index.
The growing demand for luxury products
The consumption of luxury goods increased at a 5.9% compound annual growth rate (CAGR) from 1996 to 1999.1 Sales of luxury products dipped during the shutdowns and travel restrictions forced by the pandemic, but that seems to have created pent-up demand for luxury cars, jewelry, other high-end items. That demand got unleashed in the first quarter of 2021, as companies like LVMH saw dramatic increases in sales and Lamborghini set an all-time record for car deliveries.
A number of factors could keep that long-term growth trend for luxury goods intact. First, more people keep entering the middle class and affluent ranks in China, and Chinese consumers are accounting for a greater share of the worldwide purchases of luxury goods. Nearly a decade ago, in 2012, Chinese consumers accounted for just 19% of the global consumption of luxury products. By 2018, that share had grown to 32%, and it’s expected, once year-end numbers are available, that their share in 2020 will have been 35%. By 2025, it’s anticipated that Chinese consumers will account for 39% of the global sales of luxury goods and services.2
The second key trend is that consumers increasingly want to buy the premium brand in a wide range of products. That explains the popularity of brands like Lululemon for athletic wear, Canada Goose for coats, Yeti for camping gear, coolers and insulated drinking mugs, and Peloton for exercise machines.
The final trend having an impact on the luxury market is the preference among companies to buy vs. build. Large companies are purchasing smaller firms because they’re finding it less expensive to make an acquisition than to establish a new brand in a particular market. That shift means that major companies can quickly extend their domain and become the major player in even niche markets. This buy vs. build mentality is increasing the barriers to entry for new competitors and enabling the already established brands to dominate an even wider array of product categories.
The potential of the luxury market is evident in the performance of the Emles Luxury Goods ETF (LUXE). Since its inception date of November 24, 2020, the still relatively new luxury-goods-focused ETF has outperformed the S&P 500 by a significant margin -- 13.68% vs. 9.87%.
The increased focus on “Made in America”
For decades, U.S. manufacturing had been on a decline, suffering from the impacts of globalization and the need to compete with overseas markets, where labor was often significantly cheaper. In recent years, U.S. manufacturing has staged a major comeback. A variety of factors have been contributing to this resurgence.
COVID-19 accelerated this shift, particularly because the responses to it and the pace of vaccine distribution have widely varied from country to country. U.S. companies are becoming less willing to rely on suppliers in countries that may be experiencing new shutdowns as they struggle to manage the second wave and new variants of the virus. They’re finding it much easier to rely on suppliers within the United States.
For similar reasons, the increased focus on environmental, social and governance (ESG) considerations is making it harder to rely on overseas suppliers whose environmental or labor practices might be substandard or even, short of that, simply less transparent. To meet their own standards for sustainability, U.S. firms are finding it easier to rely on suppliers within the U.S. because their ESG practices are often better known and easier to monitor.
In essence, companies always want to have lean and efficient supply chains, and using local suppliers can eliminate many of the bottlenecks that emerge when relying on foreign suppliers.
The growing geopolitical tensions between the U.S. and China have also made it difficult for companies to remain comfortable with relying on Chinese suppliers. Tariffs imposed by the Trump Administration and retaliatory tariffs on American goods imposed by the Chinese government have hindered trade between the two countries. Within Congress, there is support on both sides of the political aisle for bills that would decrease the United States’ reliance on Chinese-made products.
The Biden Administration, through its economic recovery and stimulus packages, have also provided considerable incentives for both U.S. manufacturers and for consumers who purchase U.S.-made products.
The final key trend boosting the move to Made in America has been the steps U.S. manufacturers have taken to combat the higher labor cost issue. They have implemented automated manufacturing and artificial intelligence and that has helped them increase their productivity. These positive changes have established a virtuous cycle by bringing more companies home and creating more jobs for American workers.
The performance of the Emles Made in America ETF (AMER) has made the potential benefits of investing in the theme of U.S. manufacturing’s resurgence clearly evident. The fund significantly outperformed the broad market in the first quarter of 2021 (17.21% return vs. 6.17% for the S&P 500 Index). Since its inception on October 14, 2020, AMER has also outperformed the S&P 500 by a very wide margin -- 24.94% vs. 14.7%.
Companies that draw a significant portion of their revenue from federal contracts
Investors can pursue some protection from the ups and downs of the economic cycle by investing in companies that are more immune to the vagaries of the economic booms and busts. Companies that rely heavily on government contracts for their revenue fit this bill. The government may enter long-term contracts with its vendors, which may persist regardless of whether the economy is expanding or contracting. For businesses, there are few other customers who enter contracts for periods as long as the government does. It’s a unique benefit for government suppliers to have potentially steady streams of revenue over the long-term.
The Emles Federal Contractors ETF (FEDX) focuses on companies whose weighted averaged revenue exposure to federal contracts is 50% or more. FEDX is the only ETF in the market that provides this concentrated exposure to the revenue gained from federal contracts.
The fund can add valuable diversification in an investor’s portfolio. The potential revenue of the companies the fund invests in may provide some defensive positioning against the potential declines in other types of companies’ stock prices during economic downturns.
Many of these companies with federal contracts pay their shareholders dividends and may provide a source of income for investors. It can enable investors to have at least one source of current income that isn’t highly dependent on where interest rates are and how rates change as we move through the economic cycle.
It may seem that the political environment is just as cyclical as the economy, with one party having control of Washington for a few years only to see the pendulum swing back to the opposition party in the next election. That may be the case for who controls Congress and the White House, but federal spending has steadily increased over the past several decades, regardless of who sat in the White House and which party had control over either house of Congress.
The U.S. government’s consumption expenditures increased at a steady 5.6% CAGR from 1972 to 2020, reaching $3.8 trillion in 2020. Over those nearly five decades, control in Washington switched between the two major political parties multiple times.
The potential benefits of investing in companies that get a major portion of their revenue from the government becomes apparent when you consider the performance of Emles Federal Contractors ETF. The index fund outperformed the broad market in the first quarter of 2021 (8.09% return vs. 6.17% for the S&P 500 Index). The ETF has also outperformed the S&P 500 since its inception date of October 14, 2020 (16.96% vs. 14.7%).
When it comes to ETFs, finding a proxy for the S&P 500 Index is far from the only option. There are funds that offer the opportunities to participate in an array of major trends that could potentially deliver strong returns for many years.
Prospectuses for the funds referenced in this interview can be found by clicking on the following link: Prospectus. Please read carefully before investing. Full performance and holdings information for the following funds can be found by clicking on the corresponding links:
Tags: ETF, Federal Contractors, Growth, Luxury, Manufacturing