Does It Pay to Copy Congress’ Stock Trades?

Margaret Giles: Welcome to Investing Insights. I’m your host, Margaret Giles.

If you’ve read the news over the years, you know that members of Congress and their families seem to make more money than the rest of us trading stocks. However, whether they’ll continue to outperform the market (or trade stocks at all) remains to be seen. If you still want what they’re having, there are two exchange-traded funds that follow Democratic or Republican stock trades. Zach Evens, a passive strategies analyst for Morningstar Research Services, is here to talk about what you should consider before trying to duplicate congressional investments. We’ll discuss the strategy, data, performance, and investment merit of these two congressional ETFs.

Zach, thanks for being here.

Zachary Evens: No problem. Happy to be here.

Why Investors May Want to Follow Congressional Stock Trades

Giles: All right. The Unusual Whale Subversive Democratic EFT NANC ticker, or “Nancy,” and Republican ETF KRUZ, or “Cruz,” aim to replicate stock trades made by members of Congress and their spouses. Why do the ETFs’ creators think that this would appeal to investors?

Evens: I think there are a couple potential selling points. The first is politically aligned portfolios, especially in recent years, we’ve seen more of an interest in politically aligned portfolios, so these definitely fit that bill. And then the next is the perceived stock-picking prowess of members of Congress. So you may have seen stories. There’s definitely anecdotal evidence that congresspeople tend to outperform the market or do especially well in their stock trades around market events. So I think the ETF sponsor might see these as a way for investors to capture some of that outperformance.

Are Members of Congress Good at Picking Stocks?

Giles: Cool. So the million-dollar question, are members of Congress actually good stock-pickers?

Evens: I’d like to know myself. The evidence is mixed. There have been a lot of studies going back decades that look at the stock trades of congresspeople, various datasets, and the evidence is inconclusive at best. Some studies say yes, some studies say no. While news outlets may pick up on some of the anecdotal evidence that I mentioned earlier kind of around market events—such as around the covid-19 drawdown in March of 2020, some congresspeople were well-positioned going into that event. So I’d say maybe, but the evidence is inconclusive.

The Firms Behind the ETFs: Subversive Capital and Unusual Whales

Giles: I want to get into the background of these ETFs. As you mentioned, they’re sponsored by Subversive Capital and then they use data from Unusual Whales. Can you give us some background on these firms?

Evens: Sure. So Subversive Capital is an ETF sponsor. They’re a small ETF issuer running a little over $250 million in only these two ETFs. And those ETFs, their portfolios are based off of data from Unusual Whales. Unusual Whales, among other things, is a data aggregator for the data that supplies these portfolios on the stock trades of members of Congress.

Limitations of the Data on Congressional Stock Trades

Giles: I want to get into how Unusual Whales collects that data. How do they collect congressional stock trade information? And then are there any limitations that investors should take note of?

Evens: Yes. So there are definitely limitations, but this data is based off of periodic transaction reports, or PRTs, which must be filed by congresspeople up to 45 days after a trade has been made. So that leads me into the first limitation is that this data may be delayed. So while these portfolios are a decent approximation for how Democrats or Republicans might be allocated, they don’t represent a real-time view of their portfolios. So that delay is the first limitation.

And then the second limitation is that these PTRs don’t require a specific amount, only ranges. So a Congressperson might be at the low end of the range or the high end of the range and we don’t know for sure.

And then the last limitation is that they don’t capture options trades. Some congresspeople, especially around market events, have been noted to place fortuitous options bets around certain stocks or certain indexes or things like that. And these PTRs do not capture options trades. So the portfolios of these ETFs may not fully capture the economic exposures of Democratic or Republican congresspeople.

Giles: So it seems like these ETFs are really an approximation, right? You’re not going to be totally invested in line with Congress and their families.

Evens: Right, exactly.

How Democrats and Republicans Invest Differently

Giles: I want to take a look at the portfolios. Are there material differences between how Republicans and Democrats invest?

Evens: Yeah, there are. And I’d say those differences are fairly predictable along party lines on what we know about Democrats and Republicans. The Democratic portfolio, NANC, tends to favor more growth stocks, more technology stocks like Nvidia NVDA, Microsoft MSFT, Apple AAPL, Google GOOGL, stocks like that are usually at the top of its portfolio, whereas a Republican ETF, K-R-U-Z or KRUZ, tends to favor more value names, more defensive names, or industries and sectors like energy, oil and gas, or industrials.

Giles: It’s interesting to see that people really do invest in line with their party’s values or proposed values.

Evens: Roughly. Yeah.

Both the Democratic and Republican ETFs Favor Tech Stocks

Giles: Interesting. So from there, I want to get into the similarities. Is there a significant overlap between the portfolios?

Evens: There is overlap. So while the Democratic ETF tends to favor technology stocks, the Republican ETF also favors technology stocks. So the Democratic ETF has its highest sector weighting in technology, at about 40%. But KRUZ also has its highest sector weighting in technology, at about 24%, 25%. So both these ETFs still hold technology stocks like Microsoft and especially Nvidia; just the Democratic ETF tends to lean a little further into those tech names.

How Outsize Tech Exposure Has Affected the Performance of These ETFs

Giles: We’ve already talked about whether congresspeople are good stock-pickers and what that means for their performance. So I want to get into how these ETFs have performed. They’ve got a pretty short track record, about two years. What does that performance look like?

Evens: Yeah, so I think any active portfolio manager will tell you if you had outsize tech exposure in the last two years, you would do well. So the Democratic ETF has fared better largely because of that. It’s outperformed the Morningstar US Market Index over the last two years, it’s outperformed the S&P 500 over the last two years, while KRUZ has underperformed largely because of its underweight position to technology. But I’d say it’s more representative of that technology allocation than sort of the stock-picking prowess of the Democratic congresspeople that its portfolio is supposed to represent.

Why Investors Face Concentration Risk With Thematic Funds Like Congressional ETFs

Giles: That makes sense. So thematic funds like these, and they are thematic funds, they’ve got that narrow view, they tend to carry more risk than, say a well-diversified index fund. What are the particular risks that these ETFs face?

Evens: Yeah, so one of the biggest risks is concentration risk. So if you compare it to a diversified broad market index ETF, like a Vanguard S&P 500 ETF or a Russell 1000-based ETF, those hold almost every stock in the US market. And thematic ETFs like these hold a concentrated subsection of that market.

So by not holding the entire market, you may underperform if the stocks that your ETF holds underperform the broader market or the stocks that are not held in your portfolio. And then if the stocks that are not held in the portfolio outperform the ones that you hold, your ETF will underperform. And the reverse is also true. So it may do well for periods like we’ve seen in the last couple of years where NANC has been overweight tech, but you’re really kind of giving up that broad diversification, which may open you up to underperformance if the allocation falls out of favor.

Why the ‘Black Box’ of Congress’ Investing Strategy Is Risky for Investors

Giles: I think another risk that maybe—tell me if this rings true or not—is it’s kind of a black box, right? So you have these congresspeople making decisions and then you’re kind of mirroring those. But unlike a regular index fund, you don’t have that systematic view of the strategy. Is that something that investors should keep in mind?

Evens: Yeah, definitely. So these portfolios and the trades of congresspeople may or may not have an economic rationale. So when we buy or sell a stock, it could be because we think the stock is going up. But the data for which these portfolios is based off of, it doesn’t know why a congressperson is buying or selling a stock. It just knows that the congressperson bought or sell a stock. Maybe they’re buying a house, maybe they’re sending their kid to college and they need that stock to pay for college, to pay for a down payment on a house. Or maybe they’re buying a stock for who knows what reason, economic or not. We don’t know. Whereas actively managed funds, actively managed strategies, the manager is buying and selling stocks because they think a stock will do well or do poorly in the future. Whereas, like I said, the congresspeople for which these ETFs are based may or may not make those decisions on economic reasons.

Key Takeaways on Investing in Congressional ETFs

Giles: To wrap up, what is a key takeaway you have for investors that are thinking about investing in either one or both of these congressional ETFs?

Evens: I think an investor should really understand the thesis and its limitations. So what I said about there potentially not being an economic rationale behind the trading decisions of congresspeople is one, as well as the inconclusive evidence for if congresspeople are actually good at trading stocks. Investors should read those reports for themselves, read the research, understand the thesis, and make a determination on their own for if congresspeople A) have stock-picking prowess, and B) if these ETFs are effective vessels for capturing that potential outperformance.

And then if you come to the determination that these might be interesting for you to take off the shelves, I think everybody agrees that high fees are a detractor from ETFs and from investment strategies. And funds with high fees tend to do less. Fees are a pretty good determinant of long-term performance. So their 74- and 75-basis-point expense ratio, respectively, definitely presents a high hurdle for long-term outperformance.

Giles: All right. Well, investors should certainly keep that expense ratio in mind. Thanks for coming today, Zach.

Evens: No problem. Thanks for having me.

Giles: That wraps up this week’s episode. Subscribe to Morningstar’s YouTube channel to see new videos about investment ideas, market trends, and analyst insights. Thanks to Senior Video Producer Jake VanKersen, Lead Multimedia Editor Ivanna Hampton, Associate Multimedia Editor Jessica Bebel, and Digital Communications Specialist Kumudini Devalla. And thank you for watching Investing Insights. I’m Margaret Giles, senior content development editor at Morningstar.