British-domiciled funds investing in American equities performed well in 2005 on the back of a strong dollar, and prospects for the US stockmarkets could be improving this year.Despite muted performance from the S&P 500 index in 2005, British investors with exposure to American equities generally saw good returns last year. The relative strength of the dollar against sterling was a major contributor to fund performance, with the dollar appreciating by almost 12% against the pound. The S&P 500 index rose just 3% in value in 2005, amounting to a total return of 4.9%, in dollar terms, according to Lipper Hindsight. By contrast, the average fund in the Investment Management Association North America sector returned 18.5%, with performance bolstered considerably by currency gains. The American stockmarkets have continued this trend of modest growth in 2006, with the S&P 500 index up 3% in value from January 1 to April 17. However, the dollar has weakened slightly against sterling this year. The Aggressive Adviser Fund Index included eight funds in the IMA North America sector, making up 8.7% of the index at the most recent rebalancing on November 1, 2005. The average total return produced by these constituent funds was 18.7% in 2005, according to Financial Express. Compared with most other major international stockmarkets, American equities have generally underperformed over the past few years, but with strong GDP growth over the period, are American markets better positioned to perform? American monetary policy, the size of the US current account and fiscal deficits, strong corporate earnings growth and rising consumer debt are among several factors that come into play when analysing the prospects for American equities. Komal Sri Kumar, manager of the SG American Growth fund, says: “People have worried about the current account deficit for the past four years. We are sanguine about the situation. The large deficit is a measure of the fact that the US has been the only rapidly growing developed economy over the past few years. If there were not an appetite for US paper then there would have been a problem.” The twin deficits will come down, says Kumar, and so long as the economy remains robust, he predicts no real problems for American interest rates and the dollar. “The US consumer is key to US GDP growth, with consumer spending accounting for about two-thirds of GDP,” Kumar says. Given the high levels of consumer debt and mortgage repayments, he adds, consumer spending will be hurt and GDP growth will slow for the rest of this year. Kumar predicts an annual American GDP growth figure of about 3% for 2006. The portfolio’s biggest overweight is the information technology sector. Share prices will benefit significantly from capital expenditure from American corporates, Kumar says, with companies buying new equipment and computer hardware. The high level of energy prices presents a conundrum for Kumar, who, after being underweight the sector in 2005, has increased the fund’s weighting over the past four to six months. “The demand for energy from America and Asia is not sufficient to explain the price increases,” he says. “Fears of supply disruption have come into play. It is a hard call to make but both corporates and the consumer will adjust to higher prices. Energy prices have not had a big impact on companies so far.” Valuations are also a key theme, says Kumar, with corporate earnings growth having risen much quicker than share prices. “Higher interest rates have hurt the US equity markets in the past two years,” he says. But with the Federal Reserve expected to reach the end of its interest rate hikes soon, he expects American equities to start performing. “Valuations look good and I expect growth-oriented strategies to do well,” he adds. “Investors will become more defensive and look to large-cap stocks.” Kumar expects a return of about 15% from American equities in the next 12 months, in dollar terms. Gil Knight, manager of the Gartmore US Opportunities fund, says: “We have a reasonably benign view on the US stockmarkets. There is a great fight going on between the Federal Reserve, trying to slow down growth, and the economy, which continues to power forward. “Unemployment is almost down to record lows and corporate profits are strong. Personal income continues to go up. My only concern might be a slowdown in house prices.” Knight expects interest rate increases to end after one or two more hikes and says stockmarkets have generally acted well during the period of monetary tightening. The fund has a significant overweight in technology companies, although Knight has recently sold a number of holdings, including Google and Yahoo! “The big focus at the moment is on telecommunications,” Knight says. “We expect a lot more capital expenditure in the sector.” The fund is positioned to exploit a number of themes, including changing demographics and the emergence of Asian economies, he adds. “I am a big believer that Asia will become a major part of the global stockmarkets,” Knight says. “We look to find companies to invest in that have pricing power and are producing something that Asia needs.” To exploit this theme, the fund holds several mining equipment, engineering and construction companies, including Foster Wheeler, Joy Global and URS. The Adviser Find Index – A Summary
The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs (see www.fundstrategy.co.uk/adviser_fund_index.html).