When investing in the US, many investors and advisers turn to passive funds because few fund managers succeed in consistently outperforming this mature and efficient market. However, when looking beyond mainstream US indices, passive is not necessarily best, a case in point being US equity income.
Valuations on some high-yielding shares in the US are expensive, for example, telecoms, utilities and real-estate investment trusts (Reits), although these began to sell off in May because they are vulnerable to rising interest rates. But there is value in technology shares, and some pay dividends which, while low, are predicted to increase this year.
"An active manager should hopefully be able to deal with all this," adds Juliet Schooling Latter, research director at broker Chelsea Financial Services. "Another risk is that US growth doesn't continue to be as good, but while some US equity income shares are more domestic-facing, others are more global. In this situation, an active manager should hopefully select the ones that will do well."
There are also few US equity income exchange traded funds (ETFs). Options for UK investors include SPDR S&P US Dividend Aristocrats ETF (USDV), though this only yields 2.31 per cent. It is also important to take a close look at ETFs which give more weight to high dividend stocks, since these are very vulnerable to dividend cuts as cuts accompany price drops. A passive fund may also place higher weightings on shares that have made past losses.
Growing choice
Although the US does not have a reputation as being a good market for income-yielding companies, if you look beyond index average yields there are a number of companies which pay attractive yields, which active managers can target. "The US market has historically been low yielding because technology companies didn't pay a dividend, but there are, in fact, hundreds of companies that pay a dividend in excess of 2 per cent," says Ben Yearsley, head of investment research at Charles Stanley Direct. "There are other positive reasons to look at the US: the economy is improving, there are great companies and it has come out of the financial crisis pretty well over the past two years. The budget deficit is also falling, while the strong dollar is beneficial to UK investors translating the returns back into sterling."
Barclays Wealth and Investment Management, in its tactical asset allocation model, is 'overweight' US equities on the grounds that "concerns about growth have been overdone. Large caps are profitable, solvent and liquid".
And Ms Schooling Latter points out that the US is an area which is overlooked for income, and income payouts are improving. UK investors are typically underweight the US so it is an area they could add to.
Read more on the case for US equity income
One of the main risks is the dollar weakening, though this is generally not expected just now. But not everyone is persuaded.
"I am not convinced about buying US equity income because income shares have done very well in the past four years and could be due a rest," says Peter Sleep, senior portfolio manager at Seven Investment Management. "In a recovery, which I think we have right now in the US, I would expect small companies, cyclical or value companies to do better than steady dividend payers."
US equity income funds are not suitable for low risk investors, but could be suitable for investors with larger portfolios that already own UK and global equity income funds, and investors who have the time to do their own asset allocation. Ms Schooling Latter says that US equity income could account for at least 10 per cent of an income portfolio, though ultimately your allocation will depend on a number of factors, including risk appetite, time horizon and what other holdings you have.
If you do not have the time or inclination to asset allocate, have a small portfolio or are accessing overseas equity income for the first time, a global equity income fund might be a better option. Some of these have more than half their assets in the US, so if you already own one which has a heavy US weighting then you may not want to add a US equity income fund, in case you over allocate.
"An active global equity income fund would have a bigger universe of stocks to choose from, so the chances of finding a winning active fund manager is good," adds Mr Sleep. "I think it also makes sense to buy a global fund to give you broader diversification across countries, sectors and currencies, which should benefit a long-term investor."
However, you should not consider a global equity income fund as a proxy for the US because their allocations to this country are very divergent, warns Ms Schooling Latter - anything from 15 to 56 per cent - and as they are actively managed the allocation is subject to change. "If you are thinking of investing in a global income fund, check the underlying geographic weightings," she says.
Best funds for US Equity Income
If you are persuaded by the case for US equity income, options include IC Top 100 Fund JPMorgan US Equity Income (GB00B3FJQ151), which currently yields 2.67 per cent.
Ms Schooling Latter also suggests Legg Mason US Equity Income (GB00B3TTBW75), which yields 2.38 per cent, though doesn't have a long track record as it is less than two years old.
Mr Yearsley suggests Neptune US Income Fund (GB00B68NVN20), which has the highest yield among North America funds, of 3.88 per cent. However, this has a high ongoing charge of 2.07 per cent.
Read our interview with Neptune US Income's manager
Good global equity income funds include IC Top 100 Fund M&G Global Dividend (GB00B39R2M86), which yields 3.52 per cent and has 36 per cent of its assets in the US. It also makes strong long-term total returns
IC Top 100 Fund Newton Global Higher Income (GB00B0MY6T00) yields 4.75 per cent and has 40 per cent of its assets in North America.
Artemis Global Income (GB00B5VLFH80), meanwhile, is the top performing Global Equity Income Fund over one year and second over three years, and yields more than 5 per cent. It has nearly 33 per cent of its assets in North America.
