The US stock market has performed well in recent history – really well.
The S&P 500, which is widely regarded as a barometer for the state of the US economy, has grown by 76 per cent over a five-year period to 2,474 (as at 9 August).
The traditional method of securing a slice of this outperformance is to invest through mutual funds skewed to investment opportunities across the pond, but management fees can be quite expensive.
However, cost savvy investors have increasingly opted to play the US bull market through the low cost exchange traded funds route.
ETFs, a type of index investing, can be a convenient and cost effective way of gaining exposure to the burgeoning US markets
Many investors have become disillusioned with active managers, who cherry-pick stocks with the intention of beating the market, and have instead opted for cheaper passive investments that track a market index such as the FTSE 100.
ETFs in particular have become popular as they marry the flexibility and convenience of trading stocks and shares with the same level of diversification offered by passive or active mutual funds but, typically, at a lower cost.
They are listed on a stock exchange and can be traded multiple times a day at a visible price, whereas conventional funds are priced just once a day and you do not know what the price will be before you buy or sell.
It is important to remember that ETFs closely track their chosen index so, bar the potential of tracking error where a tracker fails to follow the index accurately, rises and falls in the index will replicated.
While the US markets have enjoyed a stellar, near record performance recently, many industry commentators have questioned how long this will last. Indeed several US indices have taken a bit of a tumble in the wake of US/North Korea tensions and ongoing personnel shifts in President Trump’s White House staff, fuelling uncertainty over his domestic agenda.
Despite these concerns, the US still makes up more than half of leading global market indices like the MSCI ACWI and the FTSE All-World, which suggests the country still warrants a significant portion of investors’ portfolio.
We asked Oliver Smith, portfolio manager at IG, for his views on the outlook for the UK economy and his two cents on the best ETFs investing in the US.
Smith: US markets still warrant a significant portion in an investor’s portfolio despite worries that US stocks are overvalued
On valuation grounds, many investors would say that the US is looking too expensive with an historic earnings multiple of 21 times.
However other investors point to technology (which now accounts for 23 per cent of the S&P 500) and still see enormous growth prospects for those companies.
While it would be surprising if the US continued to outperform to this magnitude over the next five years, we still believe that the US markets warrant a significant place in an investor’s portfolio due to the prevalence of existing high quality businesses and the trend towards global technology-focused companies choosing to list in the US rather than on other international exchanges.
One element to consider, for sterling investors, is whether the returns generated by a weakening pound will reverse over the next few years. For example in 2016 the S&P 500 was up by 12 per cent in US dollars but a huge 33.6 per cent in pound sterling terms. Currency hedged ETFs will protect against such a scenario.
As the ETF market has matured, in recent years a number of global ETFs have come to the market offering small and mid-cap exposure, or factor exposures, such as size, momentum and value.
These can be a valuable addition to an investor’s tool kit, and we include a couple of these.
Firstly, one noteworthy quirk of investing in US ETFs is that they often outperform their benchmarks on a net of fees basis.
This is because Irish domiciled ETFs (which are still London listed) have a favourable dividend withholding tax treatment, meaning that the index providers which report indices net of US withholding tax factor in a higher tax charge than the ETF incurs.
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Six US ETFs to consider
iShares Core S&P 500 (CSP1) – ongoing charge 0.07 per cent
In a very competitive market, there is little to choose between the S&P 500 ETFs. With fees [ongoing charges] of just 0.07 per cent, a bid-ask spread of 0.04 per cent and outperformance of benchmark of 2.1 per cent over the past five years, this a solid choice to get market cap index exposure to the US.
It reinvests its dividends, which should also help lower transaction costs for long-term holders.
iShares S&P 500 GBP Hedged (IGUS) – ongoing charge 0.45 per cent
With Sterling looking cheap against recent history, having some GBP-hedged exposure to the US to protect portfolios against a possible weakening of the dollar is becoming more popular. iShares S&P 500 GBP Hedged recently lowered its total expense ratio to 0.2 per cent, making it a low cost way to get this exposure.
SPDR Russell 2000 US Small Cap (R2SC) – ongoing charge 0.30 per cent
The Russell 2000 was a great beneficiary of the post US election Trump Trade, but it is now one of the most expensive parts of the US market, trading at around 30 times historic earnings. Nevertheless, this ETF provides low cost exposure to the majority of this index.
PowerShares EQQQ NASDAQ-100 – ongoing charge 0.3 per cent
Technology now accounts for 23 per cent of the S&P 500, but PowerShares EQQQ NASDAQ-100 is attractive for those wanting a purer exposure. The top holdings are quite concentrated, with Apple, Microsoft, Amazon, Facebook and Alphabet (previously known as Google) accounting for 43 per cent of the index. The ETF is very liquid and trades with a tight average bid-ask spread of just 0.07 per cent.
SPDR S&P US Dividend Aristocrats (USDV) – ongoing charge 0.35 per cent
This ETF tracks members of the S&P Composite 1500 Index that have increased their dividend for at least 20 years, meaning it is investing in established businesses rather than those with the highest yield. It therefore has a huge underweight to technology, with only a 2.5 per cent position.
iShares US Equity Buyback Achievers (BACS) – ongoing charges 0.55 per cent
Amidst the smart beta ETFs offering value, momentum and size tilts, this ETF stands out as offering something totally different. It focuses on stocks which have bought back more than 5 per cent of their share capital in the previous 12 months (therefore boosting earnings per share), many of which have shareholder activists pushing for change. It is more volatile than a market cap index, but the high tracking error shows that it genuinely offers a different return profile.
What should you consider before piling into an US ETF?
Ryan Hughes is head of fund selection at AJ Bell
The US economy is the largest in the world and, in many respects, it is underrepresented in a lot of investors’ portfolios. Given the difficulties that active managers have in consistently outperforming the US market, it is no surprise to see the rise of passive investments, especially in the ETF market.
Hughes warns there is greater liquidity risk when investing in smaller ETFs
As this market has developed, the depth and breadth of choice has increased giving investors a wide range of different investment options. However, it is still important to carefully consider what approach is right for you. With options available to gain exposure to the largest companies, medium sized companies and smaller companies, let alone income options and specific factor options such as value, growth and quality, investors should look carefully at the investment strategy and cost when assessing each option.
Investors should also consider the size of the strategy as some newer funds remain small which may have an impact on the liquidity of the funds which will ultimately impact on their ability to effectively track the index. You should remember that unless you explicitly choose a share class that is hedged to GBP, you will be taking exposure to the US dollar. This can be great if Sterling weakens, boosting returns, but can be very painful if Sterling moves the other way.
For investors looking to core exposure to the largest companies in the US, the iShares Core S&P 500 ETF is a great starting point. With over $22billion (£17billion) in assets, this ETF looks to track the performance of the index and has exposure to the likes of Apple, Amazon, Johnson & Johnson and Berkshire Hathaway (the investment vehicle of the world’s most successful investor Warren Buffett).
Given its size, costs have been kept to a minimum with an ongoing charge of just 0.07 per cent making it a very cheap way of gaining exposure to some of the biggest companies on the planet.
However, investors should also remember that right now, the S&P 500 Index and Nasdaq Index are at or close to record highs after a very strong period of performance. While it is always very difficult to call the top of the market, investors should temper their expectations as a repeat of recent strong gains is perhaps a little unlikely.
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