CIO Reflections: Q2 2023

On May 11^th, 2023, Tema launched its first three funds.

It marks the start of a mission that we believe is the next chapter in thematic investing – one that focuses on investment substance and experience and moves beyond thematic narrative alone.

As these quarterly reflections will demonstrate over the coming years, our investment process is built on compelling structural themes, thematic precision in how these themes are expressed in portfolios, and a consistent investment process that aims to harness the best elements of active bottom-up investing in a risk-managed wrapper.

The funds’ first quarter was shortened and largely uneventful from a macro perspective, characterized by a rally in the market and a continued concentration around the “magnificent 7” mega cap tech stocks, led by AI darling Nvidia, that today represent almost 28% of the S&P 500 index ^[1] .

We feel this sort of environment creates opportunities as:

o   It leads to participants overlooking segments of the market, like reshoring, that, as we write about below, are clearly inflecting upwards.

o   It should force investors to think of ways to diversify beyond their core index exposure that is increasingly concentrated in a small number of stocks.

Tema American Reshoring ETF (RSHO)

“America is back in the factory business” screamed a WSJ headline. Indeed, as the chart of the quarter shows below, there has been a parabolic increase in construction spending on new US manufacturing sites in the past 12 months.

This burst of activity is helping RSHO firms across the spectrum – from aggregates (Vulcan and Summit) to electrification (Eaton) and automation (Rockwell). As a result, the fund has had a strong start – rising +16.6% during this shortened quarter.

Interestingly, early cycle firms (such as Wesco and Herc) have materially outperformed late cycle firms (ABB, Linde)^[1]. This is unusual in the face of a falling US institute of supply management (ISM) manufacturing index ^[2] and is likely the best evidence we have that the reshoring megatrend is taking hold in the US.

A case in point is Fastenal, an early cycle bellwether, where sales growth has decelerated from 11% to 5% in May^[1], following ISM, but remains very robust.

This also supports our view that reshoring is about much more than just infrastructure, though the latter still has legs given only $210 Bn of the $1.2 Tn ^[3] of the Infrastructure Investment and Jobs Act (IIJA) ^[4] funds have been spent.

The performance data quoted represents past performance based on market price, not fund NAV. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the performance quoted. For the current holdings and most recent month-end and standardized performance go to: RSHO

Tema Luxury ETF (LUX)

LUX, out of all the funds, had a harder start to its life – launching on the back of a record Q1 earnings season and a strong start to the year for many share prices. During the subsequent shortened quarter, questions arose about the sustainability of China’s consumer demand against high expectations of post Covid re-opening which itself helped propel luxury company valuations.

Despite this inducing an early swoon, the fund fared well in the period – clocking in +1.5%  share price performance .

The stock market is notorious for this sort of short-term behavior, ignoring the fact that the majority of luxury company valuations still trade below their historic 10-year averages.

In fact, talk of valuations is moot, as our chart of the quarter shows that almost 92% of share price growth in the sector has historically come from earnings, with just 8% accounted for by multiple re-rating. Encouragingly, the latter is where we expend our security analysis work.

The performance data quoted represents past performance based on market price, not fund NAV. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the performance quoted. For the current holdings and most recent month-end and standardized performance go to: LUX

Tema Monopolies and Oligopolies ETF (TOLL)

The fund had a solid start to its life, returning +4.9% over the period . Although it was a short period, positioning the fund in more cyclical monopolies (such as Moody’s, Airbus) was helpful as defensive sectors (such as healthcare) were a drag^[1].

We often get asked: ‘surely buying high ROIC businesses is just a matter of simple screening?’. The truth is far from it, as recently relayed by Michael Mauboussin, the Morgan Stanley guru.

We believe that the stocks in the TOLL portfolio not only have high ROIC ^[5] , as we can see in the Chart of the Decade, but also potential for long-term shareholder return because:

•       The market tends to expect ROIC to regress to the mean, but monopolies by their nature have much more durable returns - i.e., ROIC won’t fall.

•       Our process layers on top of that and selects stocks where expectations could be exceeded – i.e., where ROIC might rise faster than anticipated.

•       Together, we feel the combination of these factors create the best potential for excess returns.

The performance data quoted represents past performance based on market price, not fund NAV. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the performance quoted. For the current holdings and most recent month-end and standardized performance go to: TOLL

Outlook 

As we enter the second half of the year as ever the outlook is uncertain. Weakening economic growth and sharp monetary policy tightening over the last year are battling for mind share against record order books, a clear reshoring boom, consumer savings and resilience in areas like housing. In the face of this type of environment, we believe it is important to stick to the process and strong themes that aim to allow our investors to stay the course over the long term. 

For each of our themes there are key risks we are watching:

•       For LUX: the China growth slowdown against heightened expectations is an area of potential risk, especially as the comparable period gets hard again in Q3.

•       For RSHO: our eyes are firmly on the direction of the US economy, where our base case for now is likely a recession in mid-2024 that might come as a surprise to markets.

•       For TOLL: we are looking further out to 2025E to see if anything will change the prospects for our companies especially when compared to what is priced into the valuations.

^Endnotes

^[1] Source: Bloomberg

^[2] The ISM manufacturing index, also known as the purchasing managers' index (PMI), is a monthly indicator of U.S. economic activity based on a survey of purchasing managers at more than 300 manufacturing firms. It is a key indicator of the state of the U.S. economy.

^[3] Source: GSA D2D Data to decisions, Bipartisan Infrastructure Law (BIL) Maps Dashboard, https://d2d.gsa.gov/report/bipartisan-infrastructure-law-bil-maps-dashboard

^[4] The infrastructure bill, also known as the Infrastructure Investment and Jobs Act, is a proposed legislation in the United States that aims to invest in and modernize the country's physical infrastructure, including transportation, water systems, broadband internet, and electric grid, among others.

^[5] Return on Invested Capital: calculated as net operating profit after taxes (NOPAT) / Invested capital (IC)

Risk Information  

Before investing, carefully consider the Fund’s investment objective, risks, charges, and expenses contained in the prospectus available at www.temaetfs.com. Read carefully before investing.

Important Risks

Investing involves risk including possible loss of principal. There is no guarantee the adviser’s investment strategy will be successful.

LUX

Sector Focus Risk: The Fund may invest a significant portion of its assets in one or more sectors, including Consumer Discretionary and Consumer Staples, and thus will be more susceptible to the risks affecting those sectors than funds that have more diversified holdings across several sectors.

The success of companies that sell luxury goods and services may depend heavily on the disposable household income and consumer spending of a relatively small segment of the general population, rather than the consumer population as a whole. Changes in consumer taste among such segment of the population can also affect the demand for, and success of, luxury goods and services in the marketplace. Consumer spending on luxury goods and services can also be adversely affected as a result of declines in consumer confidence levels, even if prevailing economic conditions are favorable. In an economic downturn, consumer discretionary spending levels generally decline, often resulting in disproportionately large reductions in the sale of luxury goods and services.

RSHO 

Sector Focus Risk: The Fund may invest a significant portion of its assets in one or more sectors, including Industrials, Materials and Utilities, and thus will be more susceptible to the risks affecting those sectors than funds that have more diversified holdings across several sectors.

The success of the Fund’s investment strategy depends in part on the ability of the companies in which it invests to reshore or onshore services to the United States. Companies may face significant legal, financial and political headwinds in the reshoring or onshoring of jobs into the United States, and these factors may be detrimental to performance. Industrial and Utilities sector companies will likewise be subject to the risks of Government regulation, world events, exchange rates and economic conditions, technological developments and liabilities for environmental damage and general civil liabilities. In addition, many materials companies are significantly affected by the level and volatility of commodity prices, exchange rates, import controls, worldwide competition, environmental policies and consumer demand.

TOLL 

Sector Focus Risk: The Fund may invest a significant portion of its assets in one or more sectors, including Engineering and construction, Financial Sector, FinTech, Industrials and Infrastructure, and thus will be more susceptible to the risks affecting those sectors than funds that have more diversified holdings across several sectors.

The success of the Fund’s investment strategy depends in part on the ability of the companies in which it invests to maintain proprietary technology used in their products and services. Companies in which the Fund invests will rely, in part, on patent, trade secret and trademark law to protect that technology, but competitors may misappropriate their intellectual property, and disputes as to ownership of intellectual property may arise. Similarly, if a company is found to infringe upon or misappropriate a third-party’s patent or other proprietary rights, that company could be required to pay damages to such third-party, alter its own products or processes, obtain a license from the third-party and/or cease activities utilizing such proprietary rights, including making or selling products utilizing such proprietary rights. These disputes and litigations may be detrimental to performance. 

Investing in foreign and emerging markets involves risks relating to political, economic, or regulatory conditions not associated with investments in U.S. securities and instruments. In addition, the fund is exposed to currency risk.

ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Total Returns are calculated using the daily 4:00pm EST net asset value (NAV). Market price returns reflect the midpoint of the bid/ask spread as of the close of trading of the exchange where Fund shares are listed. Market price returns do not represent the returns you would receive if you traded shares at other times.

Tema Global Limited serves as the investment adviser to Tema American Reshoring ETF, Tema Luxury ETF, and Tema Monopolies and Oligopolies ETF (the “Funds”), and NEOS Investments, LLC serves as a sub adviser to the Funds. The Funds are distributed by Foreside Services LLC, which is not affiliated with Tema Global Limited nor NEOS Investments, LLC. Check the background of Foreside on FINRA’s BrokerCheck.

For inquiries: info@temaetfs.com