(Bloomberg) -- War in the Middle East and Europe, US-China tensions, climate change, threats from new technologies — geopolitical risk is everywhere. A coterie of fund managers are pitching a class of ETFs that claim to offer a hedge for all that uncertainty.

These funds, ranging in size from $8 million to $800 million in assets, strip out companies the managers say threaten national security or are vulnerable to state takeover or US sanctions. They include the Xtrackers US National Critical Technologies ETF (CRTC), which has tracked the S&P 500, returning 12.53% year to date. There are also the the National Security Emerging Markets Index ETF (NSI) and the Freedom 100 Emerging Markets ETF (FRDM), both of which track emerging markets and have outperformed the BlackRock Emerging Markets ex-China fund at various points this year. 

The logic of these ETFs remains untested. “If they can point to something and say, ‘Hey, when Xi and Biden fought, the Nasdaq dropped 5% and our index dropped 2%,’ maybe that’s interesting, compelling proof that this is somehow working,” Peter Tchir, head of macro strategies at Academy Securities, said in reference to tensions between Presidents Joe Biden and Xi Jinping.

Excluding fast-growing emerging markets in favor of an investing approach based on unpredictable geopolitical factors may be a tough sell for traders, whose chief responsibility is to make money for their clients within the limits of the law. 

 

Origins of funds

Champions of these ETFs view them as a corrective to what they see as Wall Street’s agnostic view of geopolitical developments.

They’ve pitched them to individual and institutional investors seeking alternatives to investing in companies actively working against US interests or to those just feeling patriotic.

Justin Bernier, a former naval intelligence officer, developed the National Security Emerging Markets Index ETF so clients could invest in China while dodging companies regarded as threats to US national security. 

His team uses publicly available information to screen companies on a range of criteria, including whether they’re under sanctions, work in cybersecurity, have been accused of human-rights violations, or have operated in disputed waters near China. The fund has $7.6 million in assets under management.

Wall Street veteran John O’Connor created the index underlying the Xtrackers US National Critical Technologies ETF with a similar intention. DWS, an asset management firm, created the ETF in November 2023. 

With $44.6 million in assets under management, CRTC includes companies across 14 sectors identified by the Pentagon as critical to national security, ranging from biotechnology and artificial intelligence to hypersonics and directed energy. 

CRTC removes companies it says has too much exposure to what it calls geostrategic risks, excising behemoths including Apple, Meta and Tesla.

One of the more established funds, the Freedom 100 Emerging Markets ETF, was founded by the China-born Perth Tolle in 2019. 

Her rationale: Democratic nations are sounder long-term investments because they can bounce back faster from a downturn and pose lower capital-flight risks. 

“The emerging markets universe is rife with autocracy,” she said. 

Tolle said interest in her fund increased after Russia’s invasion of Ukraine in February 2022. Investors poured nearly $70 million into FRDM in March 2022, the largest monthly inflow for the fund at that time, according to data compiled by Bloomberg. 

The fund has $848.06 million assets under management.

“Before FRDM existed, an investor who felt the same way as myself and my clients could not express that in their emerging markets allocation, mainly because it didn’t exist,” Tolle said. “So, I felt like it needed to exist.”

(Corrects the source for the creation of the Xtrackers US National Critical Technologies ETF. The ETF was created by DWS; John O’Connor created the underlying index.)

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