US equities will regain their appeal

MARKETS have certainly been focused on the United States in recent months in anticipation of further quantitative easing from the Federal Reserve and in the run-up to yesterday’s mid-terms. But despite their interest in events in the US, investors have not been putting money into US equities.

According to data from the Investment Management Association (IMA), North America was the worst selling net retail sector in August, with net sales of -£93m. Funds under management in the North American sector have actually dipped slightly over the past decade.

Separate data from the Association of Investment Companies (AIC), which represents the closed-ended investment company industry, showed that assets under management of North American-focused funds totalled just over £1bn.

There are three reasons why the US has been so unattractive. First, performance in North American investment companies is slightly below the average investment company over a number of years. Second, the S&P 500 is one of the most difficult markets for an active fund manager to outperform because the market is very efficient at pricing in any relevant news. Third, the outlook for the US economy has been gllomy in recent months.

But should investors be reconsidering renewing their love affair with the world’s largest stock market? A number of US equity fund managers can certainly see the light at the end of the tunnel and have become more optimistic about the prospects for US equities. Many companies currently have low valuations and therefore, as confidence returns and markets improve, they could prove good long-term investments.

David McCraw, manager of Aberdeen’s Edinburgh US Tracker Trust, says that valuations have not looked this attractive in recent memory, with the S&P 500 trading at just over 12 times projected earnings for the next year. Over the previous eight earnings cycles, the average actual earnings figure has been 15 times. “We believe those levels are achievable again. Given this, and the size and scale of the US economy, investors should not ignore the country,” he adds. He also dismisses fears about the economy, arguing that these concerns are already priced in and that market investors should be looking forwards not backwards.

Indeed, as the US economy recovers from recession, smaller cap stocks may be a better way for investors to get direct exposure to growth because the large caps are more multinational, says Marc Shaw, portfolio manager of the JPMorgan US Smaller Companies fund.

But the real sweet spot for US equities is the mid caps, according to Shaw. Not only do you get the liquidity that is present in the large caps, but you also get the entrepreneurial spirit of the small caps. This correlates with the data in the table below – of the top 10 funds, seven are in the mid-cap category.

While you can’t afford to ignore the world’s largest stock market, you might be better off avoiding its largest constituents and focusing on the small and mid-cap focused funds.

IN FOCUS | US EQUITY FUNDS

Of the 236 funds in the North American equity sector that have a track record of at least three years, Morningstar data shows that the average performance over the past three years is just 2.4 per cent, highlighting just how difficult a benchmark the S&P 500 is to beat. The average size of assets under management is £238.82m. The majority of funds in the top 10 are mid cap-focused while nine out of the bottom 10 are large cap funds. Two of the funds in the top 10 have funds under management in excess of £1bn.