A client asked me to look into some ETFs that he heard follow the investments made by members of Congress that are able to invest on inside information related to legislation.
After researching the question, this is what I wrote to him:
You asked about ETFs that track the investments of members of Congress. Since they are not subject to the insider trading rules for you and me, some members of Congress are able to amass large stock market gains by anticipating the market impact of legislation working its way through Congress.
That is the hook to consider these funds, but it falls flat when you read the investment strategy in the prospectus.
It is an interesting idea that could possibly be a way to create Alpha, but the actual method utilized toward the strategy does not involve any form of investment selectivity and presents no reason to expect Alpha. In fact, results do not demonstrate Alpha beyond what randomness might produce.
Those ETFs that track the investments made by legislators are:
- Subversive Unusual Whales Democratic ETF (BATS:NANC)
- Inception 02/07/23
- AUM $30 million
- Exp 0.75%
- Subversive Unusual Whales Republican ETF (BATS:KRUZ)
- Inception 02/07/23
- AUM $9 million
- Exp 0.75%
Advised by Subversive Capital Advisor LLC.
Both ETFs use data provider Unusual Whales to actively track stock holdings by members of Congress.
The strategy is to follow reports by Unusual Whales about aggregate stock current holdings of the 535 members of Congress on a trailing 3-year lookback on purchases. That’s it.
It effectively assumes that the aggregate wisdom of 535 people of diverse background and investment competence have selected their portfolios themselves (not relying on someone else) and have done so with special insight into the likely impact of legislation on corporate growth and profits of the 400-700 stocks held by these ETFs.
The mere fact that the funds hold 400 to 700 stocks in and of itself suggests the strategy is an illusion. There surely are not that many little-known special situations impacted by pending legislation and understood in stock market terms by a majority of members of Congress.
The ETF is technically active, but all they do as a practical matter is replicate a list produced Unusual Whales. For that 0.75% is an unreasonably high expense. They are tiny funds and at that scale they are losing money even at 0.75% but that is their problem not ours. They need to subsidize their fund until it reaches scale.
The method versus the concept lacks credibility on a logical basis and in actual outcome facts.
My conclusion is that the sponsor is simply reaching for an eye and ear catching marketing concept, but then completely fails to effectively operationalize the concept in a way to capture the implied benefit.
Here is selected information from the Universal Whales report which is the sole basis of the investment methodology of these ETFs.
The Unusual Whales Congress Trading Report for 2023
“It should be no surprise that Congress’s portfolios as a whole beat the S&P 500 at 25% returns YTD. Please check the caveats at the end of the report … It is possible that not all members disclosed their trades or portfolios properly over time. We rely upon delayed, sometimes inaccurate, and static data to construct their portfolios.”
The funds hold roughly 400 to 700 stocks each. The ETFs hold all stocks (excluding de minimis amounts) owned by all members of the party and their families (Democrats for NANC and Republicans for KRUZ), that were purchased as long as 3 years ago.
That is where it fails. To assume that the dollar-weighted stocks holdings of all members of a party and their families with a 3-year lookback is representative of special advanced insight into the future performance of 400 to 700 stocks is silly on the face of it.
The ETF staff do not perform any sort of filtering or selection. They just subscribe to a service that reports what politicians report to the government about their holdings, and then buy those stocks in proportion to the aggregate holdings of the party members on which the ETF is focused.
The headline strategy could be interesting if it also included filters about who is holding the stocks, when they bought them, how their involvement in the legislation suggests possible inside information, along with digging into the story for each stock to try to determine why the member of Congress or his/her family bought it. But to assume that all the holdings of all the members of a party signal some inside knowledge is basically ridiculous.
They did not outperform simply holding the top 50 stocks of the S&P 500 (XLG) and only one of the two outperformed the S&P500 (SPY).
The fact that the aggregate Congress outperformed the S&P 500 could just as easily be pointed to luck. A few members did quite well (as you would expect in any large group) and carried the balance of the Congress to better return than the S&P 500 in 2023.
There is no back test of the idea provided to demonstrate the approach works with reasonable consistency or on balance over time. The high variation in the returns of individual members and between parties and bodies in the Congress argues against the idea of special inside knowledge driving investments. In fact, the portfolios look quite ordinary.
Here are the two ETFs versus the S&P 500 and the S&P 500 Top 50. The top 50 beat them all (the Magnificent 7 effect at a minimum). The S&P 500 beat one of the two ETFs.
Here is a comparison of the top 20 holdings in each of the two ETFs and XLG (the S&P 500 Top 50). The Democrats beat the S&P 500 because of their portfolio composition tilt toward the portfolio of the top 50, but they did not beat the top 50. The Republicans underperformed because of a lower allocation to the top 50:
Stay away from these ETFs. There is no reason to expect that they will add value other than by accident.