America on the cheap

American politics may be in turmoil, with the federal government close to shutdown and states bickering over their budgets. But in the real US economy, things are gradually getting back to normal. Signs of job growth are finally emerging, the economy is growing, core inflation is low and quantitative easing is set to end in June. For all the rise of emerging markets, big US corporations are still mighty machines, and a tracker fund with rock-bottom costs is probably the best way for a UK investor to buy them.

When interest rates are rising and unemployment is falling, large-caps tend to outperform small-caps, according to James Abate Manager of the PSigma American Growth Fund, who thinks a large-cap re-rating might close the 13 per cent valuation gap between small and big stocks.

Throw in the recent underperformance of emerging markets, and the concerns about inflation in these regions, and the case for US shares becomes more compelling. But US markets are mature and liquid, so it's hard for active fund managers to consistently beat indices such as the S&P 500, which tracks the 500 largest US companies. For that reason, it makes sense to plump for a low-cost tracker fund - and they don't come much lower cost than HSBC American Index.

Our recent survey of passive funds showed that this is the cheapest tracker fund option for the S&P 500 with a total expense ratio (TER) of just 0.28 per cent. That compares to 0.65 per cent for the similar Legal & General US Index Trust and 0.40 per cent for the iShares S&P 500 exchange-traded fund (ETF).

Furthermore, HSBC American Index Fund does not have an initial charge like some open-ended funds so you can buy it directly from HSBC or via some of the main fund platforms such as Fidelity, Hargreaves Lansdown, and Alliance Trust Savings. Because it's a unit trust, there'll generally be no dealing charge on your investment, whereas buying an ETF will usually mean paying around £12.50 to transact the bargain.

HSBC American Index is almost a full physical replication of the S&P 500 index, and any deviations in stocks and sectors are tightly controlled. Although it is a passive fund, the fund's management team is able to exclude a stock at the bottom end of the index if they believe it will leave the index or faces insolvency. Managers may sometimes trade in advance or arrears of index changes, so long as the maximum stock deviation is no more than 0.05 per cent. HSBC undertakes stock lending, accepts scrip dividends and participates in placings, which can all reduce the fund's costs. Up to 5 per cent of assets may be held in futures to equitise cash inflows and to further minimise the dealing costs. The fund is backed by the global financial might of HSBC and its strong stewardship has been rewarded with an AAA rating from Standard & Poor's.

Over five years, the fund has returned a net 9.98 per cent against 11.6 per cent for the S&P 500 Composite, and over one year 12.7 per cent against 12.5 per cent. The tracking error improves over more recent periods, because in September 2009 the annual management fee was cut, and the closer tracking should continue.

You are at the mercy of swings in the index, with no active fund manager to anticipate trouble and steer clear of it. But because the S&P500 is large and diverse - no sector accounts for more than about 15 per cent of assets - this should not be a big risk. And you get exposure to sectors that are under-represented in the UK, such as technology, which is the fund's single largest exposure.

Since the fund is priced in sterling, but invests in dollar-denominated assets, you are exposed to changes in the exchange rate. If the dollar weakens, your units will return less than the underlying fund. But for long-term exposure to the world's most significant stock market at very low cost, HSBC American (which is available in income or accumulation units) is hard to beat. Buy.

Key fund data:

Source: HSBC, *Investors Chronicle.

Performance data as at 28 February 2011.

Top 10 holdings 31 January 2011

Sector breakdown: