How best to get exposure to US equities

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With an improving housing market, an energy revolution founded in shale gas and recapitalised banks, the US has re-emerged as the world’s leading macro story.

But with a widespread perception that the American market is the hardest to outperform, many UK investors remain cautious on the region and many have settled for passive options.

To some extent, the presence of Vanguard’s US Equity Index fund among the best returners supports such a call. The fund returned 53 per cent over the past three years.

That said, a look at the top-performing portfolios over three years to mid-June shows a number of consistent offerings – with 15 portfolios returning more than 50 per cent – although few come from the established giants of UK fund management.

A top performer is Legg Mason ClearBridge US Aggressive Growth, which typically holds companies for at least a decade, despite the name.

Co-manager Evan Bauman says: “When some investors see 2-5 per cent turnover on a growth fund, they question it but we have found the best way to outperform is buying and holding companies that trade cheaper than the market and outpace it in terms of growth.”

He is currently more bullish than the average US equity manager, citing below-market valuations for his favoured long-term growth companies.

“We believe the backdrop remains difficult and there should be a premium paid on companies that exhibit the type of high double-digit earnings and revenue growth we focus on,” adds the manager.

“We focus on long-term growth of earnings and cashflows, sustainability of business models and franchise value. This is very quality-oriented growth and we are big believers that the success of our portfolio and of a growth manager is driven by compounding earnings and cashflows over a long period.”

Citing further support for his bullish outlook, Bauman says corporates in the US are in the their best ever shape, with many sitting on over-capitalised balance sheets.

He expects M&A to be a key theme for the portfolio, noting sectors including healthcare, technology and energy are primed for consolidation.

Looking at the US Aggressive Growth portfolio, major sector positions include healthcare and cable and media, with little in more economically sensitive parts of the market.

Central is the notion of innovation, with the ClearBridge team seeking companies that can essentially change people’s lives and allow businesses to be more productive.
According to Bauman, the focus is on defensive long-term growth, encapsulated by his position on technology.

“Many clients hear aggressive growth and feel we need to overweight tech but we have actually been underweight for several years,” he adds.

“Think again about sustainability of earnings growth. When we look at technology, we see very cyclical, competitive markets and even for some of the biggest companies, the barriers to entry are low.”

On the tech side, the managers have focused on more innovative names that can offer sustainable growth, such as Citrix and storage businesses Seagate and SanDisk.

As might be expected, US groups are dominant in this space, with Janus and Natixis alongside Legg Mason among the best performers.

While less known to UK investors, Janus is a strong brand in its home market, grounded in the concept of independent stock-specific research.

Nick Thompson, who heads the top-performing US Research fund, says the group’s analysts seek out different sources of data, typically looking at industries through the lens of a participant rather than an external investor.

As a group, Janus has 34 global equity analysts and splits the market into seven sectors. On team-run portfolios such as US Research, they neutralise sector biases by keeping to benchmark positions but filling these allocations with best ideas from respective analysts.

Funds and trusts with highest unit/share price increase over 3 years to 24 June 2013

Source: FE Analytics
RANK FUND 3-YR RETURN SECTOR
1 Janus US Venture 72.26% IMA North American Smaller Companies
2 F&C US Smaller Companies IT 71.58% IT North American Smaller Companies
3 CF Greenwich 68.53% IMA North America
4 JPMorgan US Smaller Companies IT 67.15% IT North American Smaller Companies
5 Legg Mason ClearBridge US Aggressive Growth 66.79% IMA North America
6 Middlefield Canadian Income IT 58.26% IT North America Equities
7 Old Mutual North American Equity 57.98% IMA North America
8 FF&P – US Small Cap Equity 57.91% IMA North American Smaller Companies
9 Legg Mason ClearBridge US Large Cap Growth 55.81% IMA North America
10 Natixis Loomis Sayles U.S. Equity Leaders 54.36% IMA North America

Elsewhere, JP Morgan’s US Equity Income strategy is among the most consistent in the sector, beating the market by around 2 per cent per annum for more than a decade. Fiona Harris, a client portfolio manager on the fund alongside lead manager Clare Hart, highlights a strong income theme in the US.

She also highlights the breadth of dividend opportunities across a range of sectors, compared with the bias to a few large caps in UK products. “US companies increasingly want to reward shareholders by blending dividends with reinvesting to grow the share price,” adds Harris.

JPM US Equity Income focuses on high-quality companies trading at a discount to intrinsic value and offering a dividend yield of 2 per cent or more.

On the quality side, Hart and team look for durable franchises offering stable earnings, citing McDonalds as an example.

These will have strong balance sheets, good cashflow generation and a trustworthy management team with a long-term strategy for dividends and capital deployment. Looking at performance in recent years, stockpicking in financials has been key.

“We have had no exposure to large-cap diversified banks, avoiding names like Citigroup, Bank of America and Goldman Sachs on concerns about earnings stability,” adds Harris.

“Stocks like BoA are cheap but we struggle to look past those concerns. Instead, we have owned asset managers like T Rowe Price and BlackRock and insurers such as Prudential, which can offer our required earnings stability through their recurring revenues.”

More recently, positions in Prudential Financial, Wells Fargo and CME Group have all added to returns, with the first two rallying on expectations their earnings will benefit from any increase in interest rates and the third as a result of improved volumes coupled with reduced debt.

Another strong performer over three years is Swip North American, headed up by Nick Ford before he left the group last year and now under the group’s global equity desk.

According to the team, the fund remains exposed to late-cyclical industrials and banks, which should both should be beneficiaries of the economic recovery. “We are optimistic about the prospects for a gradual economic recovery in the US,” they add.

“As a result, we expect economically sensitive stocks in the consumer sphere such as Royal Caribbean and Harley-Davidson to do well in the near term.”