 Understanding the United States-Mexico-Canada Agreement
While on the campaign trail, Trump repeatedly singled out NAFTA – the North American Free Trade Agreement – as being one of the worst deals for Americans that he’s ever seen. Blasting former President Bill Clinton, Trump said, “[Clinton] approved NAFTA, which is the single worst trade deal ever approved in this country," adding "NAFTA was one of the worst things that ever happened to the manufacturing industry and the worst trade deal maybe ever signed anywhere, but certainly ever signed in this country." Was Trump right? Or was it just bombastic campaign rhetoric? The answer, like most things, is complicated and depends on who you ask. Nevertheless, the reality is that Trump fulfilled his campaign promise and NAFTA will be replaced by the United States-Mexico-Canada Agreement or USMCA. Background of NAFTA NAFTA – in theory – was designed to set the rules of trade and investment between the US, Canada, and Mexico. It was envisioned by President Ronald Regan and the concept was simple: reduce trading costs, increase business investment, and help North America be more competitive in the global marketplace. NAFTA was signed by President George H.W. Bush, Mexican President Salinas, and Canadian Prime Minister Brian Mulroney in 1992. It was ratified by the legislatures of the three countries in 1993, including the US House of Representatives on November 17, 1993, the US Senate on November 20, 1993 and finally signed into law by President Bill Clinton on December 8, 1993. It went into effect on January 1, 1994. NAFTA 2.0 – USMCA The USMCA has a total of 34 chapters, 12 more than the original NAFTA, which only had 22 chapters. In addition, the USMCA has a staggering 1,809 pages – 1,572 pages for the treaty, 214 pages for annexes, and 23 pages for side letters. In reading the new text of the USMCA, many would conclude that the original foundational pieces of NAFTA will remain largely in place. But according to proponents of the new USMCA, it was designed to increase labor protections, improve access to certain markets, remove barriers to certain trade and bolster reciprocity. Let’s explore a few of the key provisions:
The USMCA will be revised every six years, allowing the countries to consistently renegotiate the trade deal and avoid another NAFTA-like scenario wherein a country could threaten to withdraw. Implications for Stock Markets As your financial advisor, I don’t know the answer to that question. I do note, however, that the day after the USMCA was announced, global markets advanced as did the Canadian dollar. The DJIA rose almost 200 points for a gain of 0.7%, the S&P 500 rained 0.4% and NASDAQ lost 0.1%. But one day does not make a trend by any stretch. That being said, while the new USMCA will preserve a $1.2 trillion trade zone between the three countries, investors should keep an eye on how negotiations with China proceed. Because China is after all America’s largest trading partner. In fact, according to the Office of the United States Trade Representative (where you can read all 1,809 pages of the USMCA): “U.S. goods and services trade with China totaled an estimated $710.4 billion in 2017. Exports were $187.5 billion; imports were $522.9 billion. The U.S. goods and services trade deficit with China was $335.4 billion in 2017.” That’s why I preach diversification Costs matter. Whether you’re buying a car or selecting an investment strategy, the costs you expect to pay are likely to be an important factor in making any major financial decision. People rely on a lot of different information about costs to help inform these decisions. When you buy a car, for example, the sticker price indicates approximately how much you can expect to pay for the car itself. But the costs of car ownership do not end there. Taxes, insurance, fuel, routine maintenance, and unexpected repairs are also important considerations in the overall cost of a car. Some of these costs are easily observed, while others are more difficult to assess. Similarly, when investing in mutual funds, different variables need to be considered to evaluate how cost‑effective a strategy may be for a particular investor. EXPENSE RATIOS Mutual funds have many costs, all of which affect the net return to investors. One easily observable cost is the expense ratio. Like the sticker price of a car, the expense ratio tells you a lot about what you can expect to pay for an investment strategy. Expense ratios strongly influence fund selection for many investors, and it’s easy to see why. Exhibit 1 illustrates the outperformance rate, or the percentage of funds that beat their category index, for active equity mutual funds over the 15-year period ending December 31, 2017. To see the link between expense ratio and performance, outperformance rates are shown for quartiles of funds sorted by their expense ratio. As the chart shows, while active funds have mostly lagged indices across the board, the outperformance rate has been inversely related to expense ratio. Just 6% of funds in the highest expense ratio quartile beat their index, compared to 25% for the lowest expense ratio group.  This data indicates that a high expense ratio presents a challenging hurdle for funds to overcome, especially over longer time horizons. From the investor’s point of view, an expense ratio of 0.25% vs. 1.25% means savings of $10,000 per year on every $1 million invested. As Exhibit 2 helps to illustrate, those dollars can really add up over time  GOING BEYOND THE EXPENSE RATIO
The poor track record of mutual funds with high expense ratios has led many investors to select mutual funds based on expense ratio alone. However, as with a car’s sticker price, an expense ratio is not an all‑encompassing measure of the cost of ownership. Take, for example, index funds, which often rank near the bottom of their peers on expense ratio. Index funds are designed to track or match the components of an index formed by an index provider, such as Russell or MSCI. Important decisions in the investment process, such as which securities to include in the index, are outsourced to an index provider and are not within the fund manager’s discretion. For example, the prescribed reconstitution schedule for an index, which is the process of deleting or adding certain stocks to the index, may cause index funds to buy stocks when buy demand is high and sell stocks when buy demand is low. This price-insensitive buying and selling may be required so that the index fund can stay true to its investment mandate of tracking an underlying index. This can result in sub-optimal transaction prices for the index fund and diminished overall returns. In other words, for a given amount of trading (or turnover), the cost per unit of trading may be higher for such a strictly regimented approach to investing. Moreover, this cost will not appear explicitly to investors assessing such a fund on expense ratio alone. Further, because indices are reconstituted infrequently (typically once per year), funds seeking to track them may also be forced to buy and sell holdings based on stale eligibility criteria. For example, the characteristics of a stock considered value1 as of the last reconstitution date may change over time, but between reconstitution dates, those changes would not affect that stock’s inclusion or weighting in a value index. That means incoming cash flows to a value index fund could actually be used to purchase stocks that currently look more like growth stocks2 and vice versa. Metaphorically, these managers’ attention may be more focused on the rear-view mirror than on the road ahead for investors. For active approaches like stock picking, both the total amount of trading and the cost per trade may be high. If a manager trades excessively or inefficiently, costs like commissions and price impact from trading can eat away at returns. Viewed through the lens of our car analogy, this impact is like the toll on your vehicle from incessantly jamming the brakes or accelerating quickly. Subjecting the car to such treatment may result in added wear and tear and greater fuel consumption, increasing your total cost of ownership. Similarly, excessive trading can lead to negative tax consequences for a fund, which can increase the cost of ownership for investors holding funds in taxable accounts. Such trading costs can be reduced by avoiding unnecessary turnover and seeking to minimize the cost per trade. In contrast to both highly regimented indexing and highturnover active strategies, employing a flexible investment approach that reduces the need for immediacy, and thus enables opportunistic execution, is one way to potentially reduce implicit costs. Keeping turnover low, remaining flexible, and transacting only when the potential benefits of a trade outweigh the costs can help keep overall trading costs down and help reduce the total cost of ownership. CONCLUSION The total cost of ownership of a mutual fund can be difficult to assess and requires a thorough understanding of costs beyond what an expense ratio can tell investors on its own. We believe investors should look beyond any one cost metric and instead evaluate the total cost of ownership of an investment solution Weekly Market Update — September 29, 2018
|
Archives
May 2020
Categories
All
|
RSS Feed
ABOUT RICRic is a CERTIFIED FINANCIAL PLANNER and investment advisor. Click here to learn more.
|