Companies with high exposure to U.S. federal contracts may offer investors with uniquely stable through-the-cycle revenues as federal contracts are guaranteed by the U.S. government. A long-term allocation to companies with high revenue exposure to federal contracts may help to create a more resilient equity portfolio. The Emles Federal Contractors ETF (FEDX) is constructed to have a weighted average U.S. federal contract revenue exposure of 50% or above, and seeks to provide a competitive through-the-cycle yield.

What are federal contracts?

A federal contract is a procurement mechanism used by the federal government to provide funding for research and development projects. The principal purpose of a federal contract is to purchase property or services for the direct benefit or use of the U.S. government.

Federal contractors must maintain high operational standards. Companies that apply for a federal contract must undergo a thorough due diligence process. Moreover, federal contracts are governed by strict contract terms, which places outsized liability on those who fail to adhere to these terms.1

Contracts are funded through a diverse base of government agencies, each with separate needs and expectations. Examples of goods ordered are also broad ranging: from helicopters to cybersecurity services to protective facemasks. See summary of federal awards by government agency below.

Federal contracts by funding agency (2019)

Federal contracts by funding agency (2019)

Source: Bloomberg Government, Emles Advisors LLC

Federal procurement is a large, fast-growing industry

U.S. government spending has exhibited strong growth over several decades, with long-term growth largely unaffected by party politics. U.S. government’s overall consumption expenditures have increased at a CAGR of 5.6% from 1972 to 2019, reaching $3.7 trillion in 2019.2

Each year, the government awards hundreds of billions of dollars in federal contracts to businesses to meet the needs of federal agencies. The size of the federal procurement industry has increased sharply over the last few decades, reaching a peak of $599 billion in FY2019.3

Moreover, the Covid-19 pandemic has significantly increased the need for federal spending. As of August 2020, the U.S. government has spent $1.55 trillion in response to Covid-19 4, a figure which is likely to continue to increase regardless of the outcome of the U.S. presidential election in November 2020.

U.S. Government federal contract awards history ($ billions)

U.S. Government federal contract awards history ($ billions)

Source: Bloomberg Government, Emles Advisors LLC

The largest private-sector federal contractors tend to have long-standing relationships with the U.S. government and are typically engaged in long-term recurring business.

Over the last decade, the Top-10 federal contractor cohort has received 29.7% of all federal contract awards, with modest annual variability in its market share of total awards over this period.

Top-10 Aggregate contract awards by company (FY2010 to FY2019)

Top-10 Aggregate contract awards by company (FY2010 to FY2019)

Source: Bloomberg Government, Emles Advisors LLC

How to maximize benefits of investing in federal contractors

There are various benefits to investing in federal contractors.

Exposure to stable revenues from federal contracts may complement allocations to sectors that may be subject to revenue cyclicality: unlike federal contractors, many companies do not enter into long-term contracts, and those that do are still exposed to counterparty risk in down markets.

Cyclical revenue uncertainty and a multi-decade low-yield environment have also created a need for investments that offer quality through-the-cycle yield, like that of federal contractors. Companies with high revenue exposure to federal contracts may therefore provide investors with defensive equity exposure.

The Emles Federal Contractors ETF’s (FEDX) portfolio is constructed to have a weighted average U.S. federal contract revenue exposure of 50% or above, while seeking a competitive yield. While there exists a plethora of yield instruments in the market, there are none that attempt to de-risk economic volatility through concentrated revenue exposure to U.S. federal contracts.

Create a more resilient equity portfolio with Emles Federal Contractors ETF (FEDX)

FEDX invests in a portfolio of U.S. companies that have significant revenue exposure to federal contracts with the U.S. government, aiming to provide a weighted-average exposure to federal revenues of over 50%. We view FEDX as a long-term holding that seeks to provide exposure to stable through-the-cycle revenues, and aims to provide upside potential and a competitive yield for investors who seek defensive equity exposure. Complement or diversify your core equity exposure with the Emles Federal Contractors ETF (FEDX).

Tags: etf, Federal contractors, growth