TRADING ON THE AMERICAN DREAM BRINGS DIVERSITY TO A PORTFOLIO

For many investors, the American dream is still alive and kicking. As more retail investors look overseas for portfolio growth and income, the US is a common first port of call.

Many investors gain exposure to the US market using instruments such as exchange-traded funds (ETF) and managed funds. One extremely popular ETF is the iShares S&P 500, which tracks the performance of the Standard & Poor’s 500 Index, a broad-based US equity market index. Whilst ETFs are both incredibly useful and very efficient, there are also considerable possibilities in picking individual stocks.

Last week, the S&P 500 reached its highest level since August 2008, buoyed by positive consumer spending and market sentiment. Those who invested in an S&P ETF two years ago would have just seen their investment recover to where it was at the time of purchase. On the other hand, stock-picking investors could potentially have made a far better return.

On 4 August 2008, IBM shares were trading at $129. At the time of writing, early February 2011, those shares are now trading at $164. Investors who spotted this opportunity could have made a 27 per cent increase in the value of their investment, dealing costs aside. In the same week, McDonald’s shares traded around $65. Today, the figure is $73.

There are many others that fall into the same category, that of outperforming the index, but it is important to remember that individual stock picking does not always work out positively. For example, since August 2008, shares in Yahoo have fallen from $20 to $17. This translates into a 15 per cent loss for investors.

The key is portfolio diversification based upon thorough research in order to ensure investors are not overly exposed to any individual stock. This is all the more crucial, given that currency fluctuations too can have a significant impact on the value of overseas investments.

Another challenge for UK investors is the over-concentration of dividends within FTSE 100 companies: 61 per cent of dividend payments come from just 15 of the businesses. As a result, investors chasing yields run the risk of becoming overly concentrated in just a handful of shares. If and when a shock occurs, for example the BP crisis, this can have a disproportionately large effect on a portfolio.

This could go some way to explaining why retail investors continue to look overseas for alternative investment opportunities – there is most certainly an increased interest amongst our clients.