Foundation Fundlist review – US equity funds

Last year, we overhauled the US equity funds on our list of preferred funds for new investment.

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  1. Rob Morgan

Traditionally, the US stock market is a difficult place for active managers to outperform. This has certainly been the experience over the past decade, accentuated in the past few years by the dominance of larger companies in dictating market returns, notably the so-called ‘FAANGs’ : the quintet of Facebook, Apple, Amazon, Netflix, and Google, whose parent company is Alphabet.

These tech giants have experienced exceptional growth rates for companies their size and have really helped propel the US market upwards. Sensing their shares are too expensive, or else concerned about being too skewed to one sector, many fund managers have avoided putting too much money in these stocks. This has been detrimental to performance as shares continued to move higher and active fund managers have struggled to justify their higher fees over ‘passive’ alternatives whose job it is to mirror the performance of the index rather than beat it.

Given the low cost of certain passive or ‘tracker’ funds these often represent attractive options for exposure to the area, especially in light of the performance issues. Our customers seem to agree. Passive funds are the more popular option for dedicated exposure to US equities with investors using Charles Stanley Direct, while others favouring the active approach often consider dedicated technology funds, which are invariably US focused.

However, we believe we can find good-quality active US funds through careful filtering of the fund universe, patience and avoiding ‘closet trackers’ – funds whose stated aim is to outperform but whose make up and performance are similar to the index. As with all areas, we require active funds to offer differentiation and a defined style in order to be considered for selection.

Last year, we overhauled the constituents of our Foundation Fundlist investing in US equities with these principles in mind. We added three funds, Artemis US Extended Alpha, Fidelity American Special Situations and Merian North American Equity. Here, we take a look at how each has fared over the past year.

Artemis US Extended Alpha

Manager Stephen Moore seeks to exploit US opportunities through both long and short positions. We expect this fund to fare well (in relative terms versus the index and its peers) if US markets were to endure a sustained fall, though strong stock selection has also sometimes resulted in consistent outperformance even in a rising market; although past performance is not a guide to the future.

Mr Moore has been managing this type of fund since 2007, formerly at Threadneedle, and latterly as part of a strong US team at Artemis - most of which moved from Threadneedle in 2014. We have been impressed by his record of keeping up in rising markets but also protecting capital during periods of market stress. The fund is certainly doing something different in our view, and has the ability to provide strong returns with potentially less risk than others in the sector – though of course there is still risk involved and the fund can fall as well as rise in value.

Performance has been impressive over the past year with the fund gaining 14.8%, more than the market return of 13.9%. This was all the more impressive given the ‘net’ exposure of the fund to the market was typically less than 90% during the period owing to the offsetting effect of the short positions in the portfolio.  The fund proved particularly resilient in December 2018 during a period of market weakness.

A short position in GE was a significant success as the share price declined, as were stakes in Micron Technology, Broadcom and largest holding Microsoft as these stocks rose strongly. Current preferred stocks include gaming company Take-Two Interactive due to its development of consistently best-selling franchises such as Grand Theft Auto and Red Dead Redemption.

The manager expects a slowdown in economic growth in the US, but not a recession, with inflation to remain subdued and the Federal Reserve not to raise rates aggressively. Mr Moore feels trade and political issues will continue to result in higher levels of volatility, but that valuations largely remain reasonable.

Fidelity American Special Situations

Manager, Angel Agudo, has a value-based investment style, preferring companies that have gone through a recent period of underperformance and where little value is ascribed to their recovery potential. His philosophy is that the stock market is inefficient at pricing companies that have gone through a troubled period and are consequently unloved and out of favour. He constructs a relatively concentrated portfolio of around 50 best ideas (which can add to the risk) across a range of company sizes but with a typical bias towards medium and small sized firms.

We like the manager's contrarian style and active approach of constructing a portfolio that bears little resemblance to the index. However, given the very pronounced ‘value’ tilt of this fund we would expect it to have trouble keeping up in an environment where the market is being driven by growth stocks – as has been the case recently.

The fund struggled to keep up for most of the past year, but showed some resilience in the last few months of the 2018 during the sharp fall in US equities, notably in December. Although he views many stocks as expensive, Mr Agudo reports finding a number of solid, profitable businesses able to generate strong returns for shareholders.

As we would expect, he is steering clear of the highly-rated technology stocks and the fund has no exposure to tech giants such as Amazon, Microsoft. The selloff in the sector towards the end of 2018 did prompt him to reconsider some of these names including Alphabet and Apple, but he continues to find more compelling opportunities elsewhere.  Exposure in the sector remains very much at the unfashionable end of the spectrum through stocks such as Dell Technologies and eBay.

According to Mr Agudo, buying companies investors have widely dismissed offers the opportunity for market-beating returns in the longer term. If a business addresses a certain problem or changes tack to turn itself around investor sentiment is likely to improve, potentially propelling the share price upwards.

US bank Wells Fargo, for instance, is a company held by Mr Agudo that has historically been mired in various scandals. He believes the new management team can stabilise the business and eventually capitalise on its strong balance sheet. Importantly, Me Agudo considers that many such ‘underrated’ businesses have more limited downside than more popular stocks where a misstep or simply disappointing earnings numbers might more severely punish the share price.

Given the fund’s style are not surprised to see it lag behind the market and we consider that the manager has done a decent job.

Merian North American Equity

This fund is run on a quantitative basis designed to shut out any human emotion. The management team led by Dr Ian Heslop believes markets are not fully efficient and stock prices often diverge from their fundamental value due to investors’ behavioural biases. They aim to exploit these inefficiencies and to build a fund that can outperform in the prevailing market environment.

This means the fund can’t be pigeon holed by an investment style - be it value, growth or momentum. Instead it follows an objective and flexible approach to choosing stocks.  This has led to strong performance versus its benchmark and peer group average over the longer term (five years plus), although past performance is not an indication of future returns.

This is the most disappointing of our fund selections in the sector in terms of performance over the past year. The fund tends to perform best in a market with a sustained trend and recent volatility has presented a significant challenge. The US market has seen some large swings, and notably the S&P 500 posted its strongest start to a calendar year since 1987 (+7.9%), in the aftermath of its steepest December decline since 1931 (-9.2%). The fund was largely on the wrong side of these – slightly more aggressively positioned ahead of the downturn and relatively defensive on the upswing.

We are attracted to the manager’s diverse stock selection criteria and systematic, highly repeatable process but are wary that a volatile market without a sustained up or down trend would likely not play to the fund’s strengths. The investment process is responsive and adaptive to adjust to a new economic environment, or to the next stage of the market cycle, but can be susceptible to ‘false signals’ during a period where no pronounced trend emerges. We will monitor this carefully with the anticipation that relative performance should improve against the backdrop of a sustained trend – either markets moving higher or correcting.

Past performance table: Foundation Fundlist US Equity funds

Past performance is not a reliable indicator of future returns. Figures are shown on a % total return basis, bid to bid price with net income reinvested; Source: FE Analytics

This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.

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