Reshoring, Explained

Kinsey Grant: Hey everybody and welcome once again to the Public Podcast. I'm your host Kinsey Grant and today's show is brought to you by Tema ETFs and joining us as today's guest is Chris Seminec. He's an investor partner at Tema ETFs, and they're an issuer focused on bottom-up investing in unique structural themes like the one that I'm sure we will talk about today in this conversation. The RSHO ETF, that's the ticker R-S-H-O, excuse me, is one that we're gonna talk a lot about today because we are talking about reshoring, which is a really interesting practice that is certainly derived from a lot of macroeconomic and geopolitical realities that we're facing today and is something that is certainly an interesting force in the economy and in the investing world. So Chris, welcome to the Public Podcast. I'm excited to talk about this with you today.

Chris Semenuk: Hi, Kinsey. Thanks for having me on.\

KG: Of course, of course. So I want to start here with some big-picture stuff. When we think about bringing more jobs to the United States or bolstering the economy, the domestic economy, it seems like a relatively simple thing to do in theory. But you and I both know that in practice, it's likely much more complicated than just bringing more jobs here and bolstering the economy. Especially in the light of the last few years, we had what I think many of us would kind of consider a supply chain breakdown in 2020, shortly after the onslaught of the COVID-19 pandemic. We've been seeing this transition from more international supply chains to more domestic ones. But I would love to hear a little bit in the big picture about how you would define this reality, this part of the economy, the global economy that might be focused on this practice of reshoring. Tell me a little bit about what reshoring is and how we see those forces at play right now.

CS: Great. So reshoring, when you read about it in the newspapers, I think can be defined most simply as just companies that are locating or bringing production from overseas back to the shores of the United States. But I think it's really important for investors to step back for a minute because what that is, is the result of, you know, reshoring is a result of a process that has started a few years ago, a few years back, which is essentially that companies are number one unwinding a lot of the unintended exposures that resulted from essentially 20 or 30 years of globalization. What I mean by these sort of exposures are when they located production from shores of the US to overseas to take advantage of low-cost labor, they ended up incurring that resulted from essentially 20 or 30 years of globalization. And what I mean by these sort of exposures are, when they located production from shores of the US to overseas to take advantage of low-cost labor, they ended up incurring or ended up getting exposed to certain vulnerabilities and certain exposures by having their production located or ended up getting exposed to certain vulnerabilities and certain exposures by having their production located five, six thousand miles away. So reshoring is, I think, a response or, as I said, an unwinding of those vulnerabilities or unintended consequences of globalization. Now there are two other trends going on at the same time, and one of them is that during this time of globalization, which really started back during 2000, which was when China entered WTO. Over that 20 years of globalization, that search for low-cost labor, I think companies in the US neglected their manufacturing base here in the US. And I think we're now finding out that companies are aware of that primarily because of what happened during the pandemic and also what happened as it relates to a number of the global to a number of the global conflicts and wars that have taken place in recent years. So reshoring is a trend that's been in place, I think, for years, even though a lot of people assume it was a response to the pandemic or to global conflict. Now there's a third underlying trend and conflicts and wars that have taken place in recent years. So reshoring is a trend that's been in place, I think, for years, even though a lot of people assume it was a response to the pandemic or to global conflict. Now there's a third underlying trend, and that is that the US government is now spending or is now writing a check that represents the largest value in terms of industrial policy in history. And what the government is trying to do is, in my mind, essentially crowd in private investment here in the U.S. to essentially address that neglected industrial manufacturing infrastructure that was sort of left behind over the last 20 years as U.S. corporates looked outside the shores of the U.S. for production is in my mind essentially crowd in private investment here in the US to essentially address that neglected industrial manufacturing structure that was sort of left behind over the last 20 years as US corporates looked outside of the shores of the US for production.

KG: Yeah, that certainly makes a lot of sense, and I appreciate the context especially to illustrate that this is not something that is just a post-2020 reality, right? That reshoring and globalization been forces that have been at play for quite some time. Now, before we get into some of those, the kind of next phase of what comes after this reshoring trend here, I would love to talk a little bit about the vulnerabilities of globalization that you mentioned. What might some of those vulnerabilities be? And in what case and at what point might those vulnerabilities be encourage a company to engage in some reshoring to bring production or to bring industry back to the United States? Tell me a little bit about how that plays out.

CS: Yeah, so I think a lot of investors conflate reshoring as a company's defensive move as it relates to events that have essentially highlighted the vulnerabilities and exposures that have resulted from globalization. So there are indeed cases where companies or manufacturers are moving production or parts of production back to the US as a sort of defensive measure. That said, though, there are also examples of companies that are taking an offensive approach to reshoring. And so it's not just manufacturing. It can be a retailer, for example, that wants to locate some of its production here in the US. And they see it as an offensive measure, meaning you're closer to your customers, your design is closer to your manufacturing. And when those two factors are in place, you can have quicker product cycles, but also more product cycles. And ultimately that just results in more growth. So reshoring is not only defensive, but it's also an offensive move for companies. But broadly speaking, we're taking a very active approach to the theme. And I think that's really important for investors to keep in mind. Reshoring is not a one size fits all positive on every company that does it. And as I said, it's both defensive and offensive. Not only that, but reshoring is not only the company, the reshoring opportunity is not only companies that are moving manufacturing, but it's companies that are supplying to those people, to those companies and companies that are support services to those companies as well. And I think it's really in those areas, not, you know, it's not just about the caterpillars or the large manufacturers that you read about in the headlines of the newspapers every day it's actually about the more smaller medium-cap businesses that are kind of being pulled along with those manufacturers who are going to have to set up supply chains, support services here in the US that they didn't have before, and that's going to create underlying demand for businesses that I think a lot of people don't necessarily think about, and it's why we started the fund because we think those are opportunities we want to get in that are kind of being pulled along with those manufacturers who are going to have to set up supply chains, support services here in the US that he didn't have before. And that's gonna create underlying demand for businesses that I think a lot of people don't necessarily think about. And it's why we started the fund because we think those are opportunities we wanna give.

KG: It's also the orders of magnitude of like impact that they have on all sorts of other companies and businesses and even investing themes as well. Now, one thing that I do want to get your perspective on before we dig in more to the ETF, because I am interested to hear more about how that works and you know what you're doing over there. One thing is this idea of the balancing act that companies are always continuously having to engage in. When we're talking about reshoring specifically or globalization, even more broadly,

CS: We're talking about corporations that have to think about the timeline of their product cycles. They also have to think about labor costs. They also have to think about economic headwinds and all sorts of impacts in the economy, globally speaking. But they also do have to consider geopolitical tensions. You mentioned that there are companies that are engaging in reshoring as both offense and defense. But I am curious about how geopolitical tensions, especially with China, might impact American companies making a decision to engage in restoring.

KG: This is something that has always kind of been heating up, it's always what people use those two words to describe tensions between the United States and China. But we saw that China is taking all their pandas back from the rest of the world. They were seeing some headlines now. So I'm curious to hear your perspective on how that plays into this larger conversation.

CS: Yeah, so again, I think a lot of investors and people that sort of watch this space sort of immediately link this as a kind of US versus China issue. As I said, it's not really that. It's really an unwinding of some unintended negative consequences of globalization. Look, it took 20 years for us to kind of get into this situation. It'll take us decades to kind of unwind some of these unwanted practices. You're right. I mean, at the moment, or at least if you look back since China entered WTO, it's been pretty much a bipolar manufacturing world. We've had the US on one side and we've had China on the other. And I think what we're witnessing now is in some ways, a kind of effort by both sides to sort of reduce this sort of economic interdependence on one another. And I think Jake Sullivan, who has been very vocal as part of the current administration, now is in some ways. It's interesting that the administration puts the National Security Advisor in front of the public when talking about American manufacturing and his whole sort of focus is initially on critical areas or areas of say national security. So that's why the first wave of reshoring focused on EV batteries, on semiconductors, on pharmaceuticals. As I said, from an investment opportunity standpoint, there are opportunities there. Those companies that make those products are kind of making the reshoring journey. But beyond that, as I said, there's a whole world of the kind of picks and shovels, if you will, that people will need to use. And I think those picks and shovels will be enormous investment opportunities that I think, again, can only be uncovered using an active process. But as I said, we're moving from this sort of bipolar manufacturing world to a multipolar world. And I think that multipolar world involves not only sort of Mexico, but it involves companies moving out of China into and around the regions of China, India, Mexico, Bangladesh. But broadly speaking, you know, the fund is focused on businesses that are relocating manufacturing back to the US. We do own some foreign companies. In the cases there are companies like ABB, the Swiss company that makes a lot of electrical utility equipment. They have specifically said that they want to take advantage of the spending that the US government is putting in place in these incentives. So they are actually, in terms of their total capital investment, increasing it the most in the US in terms of their manufacturing footprint. f their total capital investment increasing at the most in the US in terms of manufacturing.

KG: Makes sense, yeah. I think within the idea of this as an investment opportunity, which is something we've kind of touched on a little bit here, I would love to hear more about the $RSHO ETF. You mentioned that it's investing in companies that are engaging in reshoring. But tell me a little bit about the premise beyond that and how it might fit into investors' portfolios, especially those who might be listening today.

CS: Yeah, so investors should see the American Reshoring Fund as, well, what it is, is about 31 companies. And the common thread that runs through every one of these companies is that they are, as we define, high quality. So high quality for us means business that generates net-free cash flow throughout the business cycle and is able to use that free cash flow and reinvest it at competitive rates of return. And then also what they don't use, pay it back to shareholders who buybacks and dividends. So if you strip away the reshoring theme of the fund, what an investor is essentially left with is, as I said, a collection of very high quality cashflow generating businesses. And when you layer on the reshoring theme, these businesses are essentially getting a tailwind of demand that we think will last at least, as I said, it took more than a couple of decades for us to kind of get into this predicament where we have vulnerable supply chains, it'll take at least a couple of decades to get out. And as a result, we think this is a very durable investment theme that we think will play out over years.

KG: Right. And for investors who are listening to this, can you explain the relevance of this idea of durability in a portfolio, especially for people who are interested in buying and holding?

CS: Yeah, so these, as I said, these are businesses that have shown a propensity to create shareholder value historically. So I think it's really important for investors when they think about the theme, as I said, it fits into a core equity strategy. These are just simply very high quality, in some cases, manufacturing businesses, in some cases, service companies that I think an investor would look at anyway. And as I said, what we've tried to do is say, okay, we've got this collection of high quality businesses that generate free cash, that generate competitive ROIC. Where are we in this portfolio in terms of businesses that intersect with this secular tailwind of demand that, as I said, I think will last years in the making? So, you know, again, the American manufacturing footprint used to be regarded as sort of the leader in the world. you know, back in the sort of 70s. And, you know, we relinquished that during the period of globalization. But I think the administration, the government, is in support of kind of rebuilding the American infrastructure. They're putting money behind it.

KG: Companies recognize the benefits of it. And the durability of the trend, I think, will be at least a couple of decades in the making. Okay. And how has this reinvestment in American manufacturing panned out? I mean, obviously this idea of, this is a long-term conversation, it's years in the making, but so far, how's it been?

CS: Yeah, so the fund launched in May and performance has been excellent. I think what we're seeing is that the businesses in the portfolio, as I said, are very high quality in nature in terms of their ability to generate free cash and invest at a high ROIC. Now, what's happened is that post the pandemic, when we've had customers and customers of the manufacturing complex. ordering two and three times what they thought they would get because we had supply chain shortages. A lot of the companies that we own in the portfolio that are manufacturing related didn't hire headcount to address that. So, as I said, as we kind of move forward going through this economic uncertain period that we're moving into with high interest rates and threat of recession, all of the companies in the portfolio are still running very lean because they didn't over hire back in sort of 21 as we exited the pandemic. So I think as and when this sort of recovery starts to pick up again in 2024, the businesses in the fund that we're invested in, I think, stand to actually over earn going forward as their revenues start to regrow again. And keep in mind that at the moment, many of the companies in the portfolio right now have backlogs that are almost double and triple what they were before they went into the pandemic. And these backlogs are still, you know, I think stand to actually over earn going forward as their revenues start to regrow again. And they keep it double and triple what they were before they went into the pandemic. And these backlogs are still, you know, too excellent what they were and are taking some time to work off. So the fact is, even if we go into a recession, these backlogs may allow these companies to continue to grow straight through a recession and then come out the air of the sun and continue growing as the economy eventually improves. So the fact is, even if we go into a recession, these backlogs may allow these companies to continue to grow straight through a recession and then come out the other side and continue with growing as the economy eventually improves again.

KG: Makes sense to me. Chris, this has been wonderful. I really appreciate you offering so much context and insight. This has been a really illuminating conversation and I appreciate you taking the time to join us today. Thank you once again to our guest, Chris Semenuk from Temma ETFs for joining us today. We will be back very soon with even more updates from the world of industrials and beyond. Thank you for listening and have a good one.

CS: You're very welcome.