How managers are responding to tariff uncertainty

On April 2nd, President Trump unveiled his administration’s proposed tariff regime. The tariffs announced on what he termed “liberation day” proved much more severe than expected, bringing America’s aggregate tariff rate to its highest level since the 19th century, even exceeding 1930’s Depression-era levels. This led to immediate declines in US share prices and a sharp increase in market volatility.

The “reciprocal” tariff rates announced on the day ranged from 46% for Vietnam, 20% for the European Union, and 34% for China, which was subsequently raised to 145%. The Trump administration has since announced a 90-day pause on the higher rate of tariffs and a series of industry-based exemptions. They also indicated a willingness to engage in bilateral trade agreements, such as the deal reported on 8th of May between the UK and the US. More significant was the agreement between the US and China reported on 12th of May whereby the 145% rate on goods from China to the US would be reduced to 30%. In turn, China committed to reducing tariffs on US exports from 125% to 10% and “suspend or cancel” non-tariff measures.

These signs of a possible thawing in trade tensions led to a recovery in US share prices following the S&P 500’s initial 15% decline. Market volatility, however, remains elevated amid the continuing lack of clarity around the application of tariffs and their impact on the global economy.

How do fund managers process this?

At Davy, many of our client portfolios include a combination of third-party passive funds (which aim to simply track a particular market index – e.g., the S&P 500) and actively-managed funds (which aim to outperform the broader market by selecting a differentiated portfolio of stocks).

The tariffs announced on 2nd April, and the frequent revisions and exemptions since, have presented challenges to fund managers as to how to interpret their impact on the portfolios they manage. We have been engaging with the active fund managers we invest with in our discretionary model portfolios to understand how they have been responding to this issue.

The first key point to highlight is the importance of not overreacting to newsflow by switching out of equities into cash, or by moving towards an overly defensive position that does not align with an investor’s risk profile. To do so in this case would have meant missing out on the 16.7% return of the S&P 500 (USD terms) from the 9th of April until the 26th of May. Despite the news and uncertainly throughout the month of April, the index level of the S&P 500 barely moved over the full month, returning -0.15% as a rebound followed the initial ~15% decline.

The active fund managers we invest with aim to generate outperformance by maintaining a long-term perspective, allowing them to exploit inefficiencies created by market participants with an excessive short-term focus. They remain fully invested and do not engage in high-turnover short-term trading in response to newsflow. The proposed US tariff regime is still highly uncertain, and fund managers are taking time to understand the implications on their portfolio companies.

Our fund managers have noted the distinction between actual announcements related to tariffs, and the market reaction to these announcements, which can present opportunities. The increased volatility of markets this year is favourable for active managers as it allows them to take advantage of mispricings when prices overshoot on the downside. One manager we recently spoke with referred to the example of a US large-cap technology firm that was sold from their portfolio in late 2024 on valuation concerns. The company’s share price subsequently declined by over 30% this year, which the fund manager believed represented an overreaction and an opportunity to repurchase the stock for portfolios.

Assessing the impact of new tariffs

Notwithstanding the current uncertainty around US tariff levels, our fund managers are attempting to understand the impact on their portfolio companies through assessing those companies’ US revenue potentially subject to punitive tariffs. They differentiate between US revenue from goods subject to tariffs, and US revenue from services that are not currently subject to tariffs. Many non-US tech names, such as German software provider SAP, generate revenue in the US through services, not goods and are therefore less impacted despite having a large US customer base.

Managers noted that many non-US names have existing production facilities in the US and will be less impacted because of this. An example referenced was French energy management company Schneider Electric, which employs 21,000 in the US across 20 factories and distribution centres.

An interesting approach in assessing the impact of tariffs was applied by one of our fund managers who employs a purely quantitative approach. The manager in question maintains a large database of quantitative metrics on circa 40,000 companies globally. Following the election of Donald Trump last November, the firm developed an assessment of those companies most at risk from rising tariffs. Their starting point was to compile a list of stocks identified by industry analysts as those companies most vulnerable to tariffs. Then, they augmented this analysis by identifying further companies whose share prices had a high correlation to this basket of stocks and that behaved similarly in response to tariff news. This approach allowed them to essentially identify those companies across a range of industries where their sensitivity to tariffs was not immediately obvious.

Quality as a buffer against tariffs

The Quality bias that we intentionally maintain in our portfolios should act as a buffer against the adverse effects of tariffs. Quality companies typically have higher and more sustainable profit margins, stronger balance sheets, higher levels of cash reserves and possess greater pricing power. A company whose products/services possess pricing power – shorthand for products or brands which consumers consider harder to replace or substitute - has a greater ability to pass the cost of tariffs on to the consumer without negatively impacting on their own margins. The ability of Quality companies to pass through price increases also provides greater protection in the event of higher inflation.

Quality companies are generally those that produce differentiated products and services that are less easily substituted. An example would be the manufacturer of a specialist airplane part that represents a critical input in building an aircraft. This cannot be easily replaced by a substitute without the aircraft manufacturer committing to rigorous testing; the company producing the part possesses pricing power as a result. In contrast, companies whose products are more commoditized can be easily substituted and are therefore unlikely to be able to pass through tariff increases to their US consumers.

Impact of volatility on active management

It has been well documented that historically low share price volatility and dispersion across stocks, together with the dominant performance and narrow market leadership of the Magnificent 7 group1, added up to a very challenging environment for active managers in 2023 and 2024. This year the news flow around tariffs has contributed to a change in market leadership, greater share price volatility and wider dispersion across individual stocks.

These factors are all supportive of active management in general, benefiting those fund managers that maintain a disciplined approach to company valuation and uncovering mispricings. We continue to believe that investing alongside disciplined and skilled active managers and maintaining our Quality bias will allow our portfolios to better withstand the volatility and uncertainty associated with greater US protectionism.

1Amid market concentration, is it time for an active approach?