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Ignore the US at your peril

US valuations are high, but you should still have some exposure in your portfolio, argue advisers
July 2, 2014

Valuations of US equities may be high compared with other stock markets, but advisers still argue that investors who completely ignore the US do so at their peril. US shares represent around half of global equity markets by stock capitalisation, and Jason Hollands, managing director, business development and communications at Bestinvest, points out that this country is home to many world-class businesses with dominant positions in numerous growth sectors such as biotech and technology - which are not as well represented in the UK.

"Record stock market levels should be seen as a warning sign rather than an opportunity to buy, and if sentiment deteriorates or if corporate earnings don't improve from their current levels, it would be no surprise to see stocks falling in the short term," says Patrick Connolly, certified financial planner at Chase de Vere. "But we continue to hold US equities in our client portfolios because the US economy is a huge driver of global growth and home to many excellent and profitable companies. This, coupled with accommodative fiscal policies, and the many potential benefits of accessing shale gas and oil, should be positive for risk assets such as equities in the medium term."

Tom Stevenson, investment director at Fidelity Personal Investing, adds that the average multiple of expected earnings for US equities this year is about 16, which while higher than most other markets is not excessive against a backdrop of economic recovery supported by continuing monetary stimulus. "The winter slowdown looks like being just that and not something more serious," he says.

Passive play?

Increasing numbers of investors in recent years have turned to passive tracker or exchange traded funds (ETFs) for US exposure because many fund managers fail to outperform these mature, efficient indices.

"The S&P 500 is a notoriously difficult index to beat - these companies are so comprehensively pored over by scores of brokers and analysts it is a serious challenge for an investor to spot something about a business that the rest of Wall Street has missed," says Mr Hollands.

Martin Bamford, managing director at chartered financial planner Informed Choice, favours index trackers for reasons including their low charges, and because their returns are pretty much in line with the market, rather than underperforming.

Unlike the UK market, US indices are broad-based across sectors and shares, so you are less likely to get overexposure or have indices skewed by the performance of one share or sector. "This makes another argument for using passive," adds Mick Gilligan, head of research at Killik. "But while there is a strong case for passive funds, with certain strategies such as value and small and mid caps, over time an active approach can do well."

For this reason, Mr Hollands also suggests investing in core US large caps via a passive investment and complementing this with a US fund focused on smaller companies or with a strong style bias.

But he adds: "At the moment, we are quite cautious on the US market as it looks expensive, with volatility incredibly low, so it could correct. If that happens, you don't want to be in an index fund."

Best US funds

If you are going to drip-feed or invest regularly, a tracker fund is probably more cost-effective because every time you trade ETF shares you incur broker fees. But if you are going to invest a lump sum, then you could consider an ETF.

"Our preferred fund is HSBC American Index (GB0000470418), which has ongoing charges of 0.28 per cent and aims to track the S&P 500 index using full physical replication," says Martin Bamford, managing director at chartered financial planner Informed Choice. "Another good option is the Fidelity Index US Fund (GB00B8G3MY63), with an ongoing charge of 0.3 per cent (for the retail share class), also tracking the S&P 500 index."

We have four US funds in our Top 50 ETFs, including the SPDR S&P US Dividend Aristocrats UCITS ETF (USDV). Mr Gilligan says the US is a good area for income because it has one of the biggest choices of this kind of stock.

Our Top 50 ETFs also include SPDR S&P 500 ETF (SPX5) with a 0.15 per cent ongoing charge and PowerShares EQQQ Nasdaq-100 UCITS ETF (EQQQ), which tracks the performance of 100 of the largest non-financial companies listed on the Nasdaq stock exchange. It has a 0.3 per cent ongoing charge.

For active exposure, Mr Hollands suggests Legg Mason US Smaller Companies Fund (GB0034100932), which has had a relatively tough time in recent years as it only invests in quality smaller companies with robust balance sheets. "However, as quantitative easing ends and policy normalises, we expect the market to recognise quality again and that should be reflected in this fund," he says. It has a 1.76 per cent ongoing charge.

We include two US small-cap investment trusts in our IC Top 100 Funds. JPMorgan US Smaller Companies Investment Trust (JUSC) beats the Russell 2000 index over one, three and five years and has a 1.76 per cent ongoing charge. Jupiter US Smaller Companies (JUS) also beats the Russell 2000 index over one, three and five years, and has an ongoing charge of 1.08 per cent.