When it comes to the US market, passive funds are the way to go. Or are they? Up to now, the US market has been on a bull run, with a tide of quantitative easing (QE) lifting all boats. That has left value-focused managers languishing behind their benchmarks while cheap passives easily returned the gains of the S&P 500. However, the end of QE is bringing with it some sticky questions about whether or not the US recovery has really taken hold. Meanwhile, a rate rise is looming. That would bring an end to the economic heyday experienced by companies across the market.
Investing in the US could be about to change. Instead of surfing the crest of an equity wave in a cheap passive fund you could find yourself rockpooling at low tide and need the help of a discerning manager.
Why you are underweight the US If you were dividing your pot into roughly the same split as the MSCI World index, you would have 58 per cent of your pot invested in the US. Although a home bias is understandable, you are likely to be less invested than you should be in this developed market. Darius McDermott, managing director at Chelsea Financial Services, says: "UK investors are much happier having 50 per cent invested in the UK as a developed stock market. They have faith in our own currency and it tends to have more familiarity - people know who Shell and BP and M&S are. "We have 5 per cent of clients in the US and at one stage had more in emerging markets than the US," he adds. He says investors should have more in the US, but has been sceptical about the choice of funds and valuations. Jason Hollands, managing director of Tilney Bestinvest, says: "UK investors ignore the US market at their peril given that it's home to so many significant businesses, especially in areas such as technology. Other niche businesses like biotechnology are probably 80 per cent housed in the US. "UK investors' liabilities are in sterling, so you should have a sterling bias and it's still sensible for the UK to be the biggest single exposure, but after that the US should be a reasonable component of your portfolio along with the other regions of Europe and Asia." |
The active vs passive battle
There is no doubt that active managers have not covered themselves in glory. Of the 114 funds in the Investment Association's North America sector, fewer than 20 managed to limp past the 96 per cent return delivered by the S&P 500 over five years.
Investment trusts performed better - JPMorgan American Investment Trust (JAM) returned almost 100 per cent over the same period, trumping its Association of Investment Companies' sector average and benchmark index.
But when costs are considered, it is little wonder passives have been more tempting. Neptune US Opportunities (GB0032310129) has an ongoing charge of 1.67 per cent and returned just 60 per cent over five years. Compare that with the iShares Core S&P 500 (CSPX) which has an ongoing charge of 0.07 per cent and returned the index - 96 per cent - over the same period.
"The one region where we struggle to pick funds has been the US," says Mr McDermott. "It could be because it's such an efficient market - there is so much market information available it's hard for managers to get an edge." It's the one place where I would even consider passive, and that's saying something because I do believe that we can find superior funds to beat indices most of the time."
"Active managers do seem to struggle in the US and the best thing to do in that case is buy a low-cost tracker or even smart-beta ETF to get diversification," says Peter Sleep, senior portfolio manager at Seven Investment Management. Mr Hollands says: "Even Warren Buffett has said his wife should buy a low-cost S&P 500 tracker in the US."
Isn't the US expensive?
A common assertion about the US stock market is that it is expensive and headed for a fall. Since 2008 it has been one of the best performing markets in the world and since 2010 the S&P has stormed past the FTSE All-Share. Can this continue?
Mr Hollands is nervous about investing in the US because "valuations look expensive compared with other markets". "It wouldn't be my first port of call," he says.
Ms Sutton says that the most "heat" is in areas of technology and biotechnology, but says "we don’t think valuations are particularly high".
"You have to be selective and it's true that the market as a whole is not cheap, but you have some stocks that are looking stretched while other areas still look appealing in valuation terms," she says.
But most agree that the rise and rise cannot continue. "There will be a change of leadership in the market because you can't have this going on forever and people will be more discerning about valuations to find risk rewards," says Ms Sutton, who believes that 2016 will be the year that active managers take back the crown from their passive rivals.
