Alex Brandon/AP
- The EventShares US Tax Reform Fund was launched last week; its methodology can shed crucial light on how to trade Trump's tax plan.
- EventShares CIO Ben Phillips says that, from an investment standpoint, the biggest focus should be on the corporate tax cuts.
If you're going to create an exchange-traded fund around a specific policy proposal - such as tax reform - you'd better be able to identify the companies that will be most affected by it.
That much should be self-evident. Actually nailing it, though, isn't so simple, because tax reform has so many different aspects to it, and certain facets of it are proving to be much more exciting to investors than others.
EventShares just launched the first policy-driven ETF. It's called the EventShares US Tax Reform Fund, and in a recent interview its chief investment officer, Ben Phillips, told Business Insider how to wade through investor sentiment and political action to pick the most likely beneficiaries of the Republican effort to cut taxes.
Pulling less weight will be major exporters - or those most likely to benefit from a repatriation tax holiday - and companies poised to be positively affected by capital-expenditure deductions. Instead, focus on the companies paying the highest effective tax rate because they're the ones with the most to gain.
With this in mind, two-thirds of the tax reform ETF is made up of more domestically focused small-cap stocks with $1 billion to $10 billion in market cap, since they're poised to benefit most from a lower US tax rate, Phillips says.
Beyond the methodology for the tax reform ETF - outlined in more detail below, along with single stock picks - Phillips and I also talked about how the fund came about in the first place, as well as what other ETFs EventShares might have up its sleeve in the future.
This interview has been edited for clarity and length.
Joe Ciolli: Can you walk through the methodology for the tax reform ETF?
Ben Phillips: Right now, the fund is 100% equity, equal-weighted, and thoughtfully active. We want to rebalance quarterly, like most traditional ETFs, but we still reserve the right to change the portfolio intra-quarter if we need to, or if it's valuable to fund holders.
Tax reform really focuses on three key buckets: tax cuts (largest, with about half), exporters, and capex deductions. Of course a lot of companies can fit into multiple buckets. We drill down on securities. We expect to move the most on the policy initiatives.
Roughly two-thirds of the portfolio is small-cap stocks, with $1 billion to $10 billion of market cap. The rest of the companies are bigger.
One of the tax-cut beneficiaries, in our opinion, is Caleres. They benefit from a shift to a territorial tax system. They make shoes in the US. They're one of the few US-centric retailers that actually makes its products here. They're not like many other retailers. The fact that they make them here puts them at a competitive advantage.
Fiserv is a large-cap high taxpayer, and they stand to benefit pretty significantly from tax reform, just because of their high rate.
We have Phillips 66 in there, and the idea there is that they pay high taxes, and also would benefit from the fact that lower taxes would make US oil and gas exporters more profitable relative to the rest of the world.
Within exporters, you have Ford, which has the largest amount of local production out of any car company in the world, which gives them the potential to see the biggest benefit from tax reform.
LyondelBasell is a triple whammy - it has a high tax rate, it's a major potential beneficiary from capex deductibility, and US-produced plastic pellets would be more competitive on a global basis.
Ciolli: What about repatriation specifically?
Phillips: We don't have any in there just for cash repatriation, although a lot of our components have that embedded. It's really a one-time event, and it doesn't have a huge multiplier effect on corporate market valuations. We thought it was much more beneficial for a company that receives tax cuts, which would help it improve its earnings stream into perpetuity.
Ciolli: In terms of the Trump tax plan being released this week, what are you watching most closely?
Phillips: The TAXR portfolio is built specifically around the tax reform framework announced by congressional leadership on September 27. It's largely focused on the corporate beneficiaries.
A lot of the changes being discussed and debated after that announcement in late December are on the individual tax rates. We think the corporate tax cuts are most likely to stand. The exporters are still likely to benefit from a lower tax regime, and we think the capex reduction will stay. We don't see much changing on the corporate side. It's really important how the Senate receives it, more so than just the House announcement.
Ciolli: Does some of the opposition we've seen affect the corporate side of things? Or does it not matter to you because your ETF is a way to play either side of the trade?
Phillips: People can express a view on the short side if they don't think tax reform is going to go through. Our internal view, however, is that there's enough impetus in DC to get some form of tax reform done.
People can express a view on the short side if they don't think tax reform is going to go through. Our internal view, however, is that there's enough impetus in DC to get some form of tax reform done.
Whether that includes the full package, that's to be determined. But I think there is enough momentum behind tax reform to get something done, and the corporate side specifically is highly likely.
Ciolli: Given their composition, do you think your funds can be used as a proxy for investor sentiment around tax reform?
Phillips: You can definitely get some view into what those that are investing in ETFs or public stocks are saying, and you can read the tea leaves around sentiment shifts that are going on.
In mid-August, there was more of a focus on tax reform, and we saw a lot of activity in those stocks in our portfolio. They give you really interesting indicators.
More important, the most value for investors is if some tax-reform legislation goes through, and then the expected performance of that fund ends up being very strong. The goal is to have a really strong fund in and of itself with this embedded tax-reform catalyst. But leading up to the Senate vote, it might be an important indicator to watch.
Tax reform has implications for almost every company that does business in the US, as well as for every person who lives in the US.
Ciolli: What was the genesis for the tax-reform fund? How long ago did you start working on it?
Phillips: Two of the three cofounders are Goldman alums. While we were at Goldman, we saw these institutional products being offered to institutional clients. We saw these high-tax baskets offered by various large banks. Our thought was that these products were out there, but only the big banks offered them, and they were often expensive and illiquid. The thought of bringing a product and an ETF wrapper to anyone with a brokerage account was appealing.
Ciolli: The launch seems very well timed. How did you anticipate the need for a fund like this?
Phillips: Tax reform has implications for almost every company that does business in the US, as well as for every person who lives in the US.
We thought that if there really is major tax reform, this deserves a stand-alone product.
Ciolli: Do you have any other similar ETFs planned for the future?
Phillips: The European Union Breakup Fund (ticker: EXIT) is expected to be our fourth fund. Brexit was the genesis of the idea. When we saw it occur, it made us think that Europe has some geopolitical questions that we should be asking, namely, what happens if companies start to leave the EU, and what are investors supposed to do about that? There's no product out there like that. I would say stay tuned for 2018.