What's the best way for UK investors to get exposure to the US?
The US is the largest and arguably still the most dynamic economy in the world, so despite sky high valuations most investors want a decent level of exposure to its thriving companies. The question is what strategy to take when buying in or adjusting existing holdings in such an expensive market, especially in light of risks like inflation, higher interest rates and a likely government clampdown on technology firms. We look at what is driving US success and whether it will continue, and which funds are best placed to exploit positive trends and withstand future upsets. The US is getting back on its feet after the pandemic and has a new president engaged in a major spending blitz to support the economy, says Bestinvest managing director Jason Hollands. Measures so far include more than $400billion in cash payments to US adults, while Congress has just reached a bipartisan deal on a $1.2trillion infrastructure investment package for roads, bridges and broadband, he explains. 'Not only is the US the largest economy on the globe, at circa 22trillion, a position it has held since 1890, when it comes to the size of its share of global stock markets, the US is the dominant force. 'Measured by market-capitalisation, 58 per cent of the MSCI AC World Index of global equities is accounted for by US-listed companies. 'By way of contrast, the second largest share is Japan with 6 per cent representation, China ranks third with 4.9 per cent and the UK is in fourth place with a 3.9 per cent share. Investors therefore ignore the US market at their peril.' UK investors are under-exposed to US  Hollands says that as well as gaining exposure directly through US funds, many UK investors get access via global equity funds, and total investment in US equities through funds is likely to be around 199billion. 'This is equivalent to 22 per cent of all the total amount held in equity funds and still less than the 26 per cent of total equity funds that are held in UK equities.' He says this means historically UK investors have been under-exposed to US companies - a costly decision over the last decade as it has been the standout performer. 'In local currency terms, the S&P 500 Index of leading US companies has delivered an impressive total return of 283.3 per cent over the last ten years, outpacing the MSCI AC World Index (163.2 per cent) and UK equities (79.3 per cent),' says Hollands. 'In sterling terms, the returns have been even better for UK-based investors, with the S&P 500 Index rising 343.9 per cent, boosted by a the strength of the dollar over this period.' 'Investors in the US have ridden a technology-driven wave over the past decade,' says Rob Morgan, chief analyst at Charles Stanley Direct, says:. 'The outperformance of these giant stocks means just five, Facebook, Amazon, Alphabet (Google), Apple and Microsoft, account for nearly a quarter of the S&P index  so index or tracker funds that follow it have this proportion too. Rob Morgan: 'Investors in the US have ridden a technology-driven wave'  'The broader technology complex, including tech and e-commerce stocks residing in other sectors, accounts for about 40 per cent. 'Clearly the 'digital revolution' continues to be a major driver of growth and investment returns, but investors do have to question whether growth will slow down for these behemoths and whether a tech-focused portfolio will continue to outperform.' Darius McDermott, managing director of FundCalibre, says: 'The US is the home to thousands of the most dynamic companies in the world  all of different shapes and sizes. 'It's a broad market, ranging from old industry stocks to some of the most high-tech, growth-driven businesses. 'There has been an unprecedented march forward by US equities in recent times and, unlike the UK for example, its index is now well-ahead of pre-pandemic levels. 'The bottom line is the US is home to a lot of dynamic companies, and clearly you need a long-term allocation to them.' 'The greatest risk to the US stock market is from inflation and interest rate expectations rising, and the biggest factor in this over the next 12 to 18 months is the labour market,' says Morgan. 'There are an estimated eight million fewer jobs than at the pre-pandemic peak. Should these jobs return there will be additional consumption, which could prove inflationary for both goods and services and for wages. 'Should a tight labour market emerge, the Federal Reserve may be forced to act sooner rather than later.' Morgan says it may not be probable but is certainly possible that inflation picks up significantly for an extended period, a scenario for which some investors' portfolios could be poorly equipped due to exposure to tech firms. 'Technology companies are often "jam tomorrow" businesses investing to secure big future profits as opposed to near term ones. 'Higher inflation and interest rates have the effect of making the value of those profits worth less in today's terms. Having benefited from falling interest rate expectations over the past few years, technology and growth stocks more generally could encounter a strengthening headwind if these start to rise.' He adds that governments are 'desperate' to raise money after the pandemic and the largest companies with the most significant revenue which are seen to have done well from the crisis are likely to be in their crosshairs  Darius McDermott: 'The US is the home to thousands of the most dynamic companies in the world'  'Taxation and regulation could ultimately impact earnings. The tech giants are mature companies with vast earnings and great resilience but the more they grow, the greater the risk of political backlash.' McDermott says that while US success has been driven by a handful of tech behemoths, known as the FAANGs (Facebook, Amazon, Apple, Netflix and Alphabet/Google), there is a growing consensus that these companies are starting to look too expensive to invest in for growth. But he goes on: 'There is an alternative view that most of them have got the earnings to continue that growth trajectory  as demonstrated by the strong results many of those companies have had in the first quarter of 2021. 'You do have to worry a bit more about inflation in the US, which currently stands at 5 per cent. 'The Federal Reserve has already indicated it may raise interest rates sooner than previously thought in reaction to rising inflation. We'd still argue this inflation is transitory, but it is perhaps more embedded in this system than we previously thought earlier this year.' Hollands warns the US is a 'must have' market for the long-run, but is not one for bargain hunters - and points out that US private equity funds have been notably active in making bids for UK companies recently. 'US equity indices have been hitting all-time highs recently and valuations on US equities are well above their longer-term average. 'The companies in the S&P 500 are, in aggregate, trading at share prices 21.2 times their forecast earnings for the next year. By way of comparison, UK companies are trading on 13.7 times forecast earnings.' He also regards inflation as a worry, saying: 'The huge amount of fiscal stimulus being pumped into the US economy could lead to persistent inflation if the economy starts to overheat.' 'If that happens it may force the hand of the Federal Reserve Bank to reduce its own support measures, leading to higher borrowing costs.' Jason Hollands: 'Don't be surprised if the UK market has a better run that the US for a change'  Hollands adds that the US market has a heavy skew to 'growth' sectors, with technology stocks representing over 26 per cent of the S&P 500 Index and communication services companies like Alphabet and Facebook representing 11 per cent. 'These types of businesses have done fantastically well  especially last year - but more recently it is more cyclical parts of the market with greater earnings recovery potential such as energy companies, financials and commodities  and those which are seen as better positioned to weather higher inflation that are leading the way. 'The UK market has greater exposure to these types of sectors than the US and so in the near term, don't be surprised if the UK market has a better run that the US for a change.' Jason Hollands tips  HSBC American Index (Ongoing charge: 0.06 per cent)  Index tracker funds, which mimic the overall pattern of a market index for a small fee, have become a very popular route for investing in the US market which is a notoriously difficult one for active fund managers to beat. In fact even Warren Buffett, the legendary US investor, has stated that 'in my view, for most people, the best thing to do is to own an S&P 500 index fund'. For example, the HSBC American Index fund replicates the S&P 500 for tiny ongoing annual costs of 0.06 per cent on its C shares. This is a fraction of the costs of an actively managed fund that tries to deliver better returns than the markets. The ongoing charge is the investing industry's standard measure of fund running costs. The bigger it is, the costlier the fund is to run. The ongoing charge figure can be found in the Key Investor Information Document (KIID) for any fund, usually at the top of page two. To track down these documents, put the fund name and 'KIID' together in an internet search engine. Read more here about investment charges. Invesco FTSE RAFI US 1000 UCITS ETF (Ongoing charge: 0.39 per cent)  For those who like the thought of a low cost fund that cuts out the judgement of a fund manager, but worry about current US share valuations, one option could be a factor fund. These track a basket of shares but based on a different set of criteria than size alone. The Invesco FTSE RAFI US 1000 ETF owns the 1,000 largest US companies  so is highly diversified  but re-weights them based on four fundamental criteria: book value, cash flow, sales and dividends. This leads it to have less exposure to companies on very high valuations and tilted towards companies with more defensive characteristics. The fund is listed on the London Stock Exchange and has ongoing costs of 0.39 per cent. Brown Advisory US Sustainable Growth (Ongoing charge: 0.9032 per cent)  An increasing number of investors want to back companies with strong records of environmental sustainability, social responsibility and high standard of governance. This fund, which is managed by a US firm with a long track record in this space, incorporates both positive and negative screening criteria including avoiding companies that derive the majority of their revenues from alcohol, gambling, pornography, tobacco, military equipment, fossil fuels or that use animal testing for nonmedical purposes or do not exhibit strong ethical policies and practices. Morgan Stanley US Advantage (Ongoing charge: 0.85 per cent)  While many actively managed US equity funds have struggled to beat the market, there are still funds with strong track records if you search for them. For example, the Morgan Stanley US Advantage fund has returned 143 per cent since it was launched in November 2016, compared to an 83 per cent return from the S&P 500 over the same period. The fund is managed by Counterpoint Global, an internal boutique within Morgan Stanley, and is focused on steady growth businesses with sustainable competitive advantages, such as strong brands, scale, network effects, or advanced technology or Intellectual Property. Federated Hermes US SMID Equity (Ongoing charge: 0.85 per cent)  With many investors getting their US exposure through trackers or global funds, this means they are usually invested in the very largest US companies. It is easy to overlook the opportunities among small and medium sized US businesses, some of which may go on to be the big beasts of the future. The Federated Hermes US SMID Equity fund fishes in this pond and might be used to dovetail a funds targeting larger companies. Its largest holdings include Wintrust Financial Corp, a family of community banks, and PTC, a technology company whose specialisms include augmented reality. Rob Morgan tips  Fidelity Index US (Ongoing charge: 0.06 per cent)  A broad investment such as a low cost tracker fund can help cover all bases as it tracks all of the market and isn't just reliant on tech. Premier Miton US Opportunities (Ongoing charge: 0.84 per cent)  The fund can access ideas from across the size spectrum and is well spread across a variety of different industries. With a portfolio skewed towards small and medium-sized companies, no 'FANG' stocks and a portfolio that looks entirely different to the index it could make a good diversifier to funds more aligned with the index or investors that already have lots of tech exposure. The managers, Hugh Grieves and Nick Ford, also run a 'concentrated' portfolio of around 40 stocks, which increases risk compared to funds with a greater number of holdings but ensures their highest conviction ideas contribute meaningfully to performance. The managers aim to be patient, buying at an attractive price to optimise potential reward for risk taken. Darius McDermott tips  T. Rowe Price US Large Cap Growth Equity (Ongoing charge: 0.57 per cent)  If you are a believer in those big tech plays, you might consider the likes of this fund, which has a number of those companies in its top 10. Manager Taymour Tamaddon collaborates with the T. Rowe Price analyst team to find companies which demonstrate innovation and change. Schroder US Mid-Cap (Ongoing charge: 0.89 per cent)  Small-caps tend to historically outperform their larger peers during periods of economic acceleration. The only risk would be if inflation does go through to wages, because small caps are two times more labour intensive than large caps. A fund worth considering is Bob Kaynor's Schroder US Mid-Cap fund, which also invests in smaller companies. The team target three specific types of stocks: 'steady eddies' act as ballast in the portfolio; 'mispriced growth' are stocks where Bob feels the market has not fully understood the company's earnings potential; and 'recovery-type' situations. JPM US Equity Income (Ongoing charge: 0.7894 per cent)  Despite the naturally lower yielding nature of the US market, it has a long history of dividend payments, an increasing number of companies now paying a dividend and a number of dividend aristocrats  companies that have increased their dividends for 25 consecutive years or more. For this I'd look to the JPM US Equity Income fund, where manager Clare Hart will look for undervalued companies that exhibit durable franchises and strong management teams. Clare keeps an astute eye on risk management, with a diverse spread of names to ensure a stable, above-market yield when building a portfolio of 85-110 holdings.