The best US funds that own more than tech

Despite their categorisation, ‘global’ funds that track global equity indices are mainly invested in US large-cap companies. For example, US equities accounted for 70 per cent of the MSCI World Index at the end of October, and the index's three largest components were Apple (US:AAPL), Microsoft (US:MSFT) and Amazon.com (US:AMZN). And these three, along with four other technology related megacap companies – Nvidia (US:NVDA), Alphabet (US:GOOGL) Tesla (US:TSLA) and Meta (US:META) – account for over a quarter of the S&P 500 index at the moment.

So if you have a substantial amount invested in a global or S&P 500 tracker fund or are thinking of adding to US exposure on top of these positions, consider diversifying via exposure to other parts of the market and economy. The US market has been one of the strongest regional performers in 2023, but this has been very much driven by the so called ‘magnificent seven’ stocks listed above, all of which have also performed very well over the past decade.

“However, the apathetic market reaction to their latest results shows that relatively high expectations are already in the price [of these stocks],” argues James Yardley, senior research analyst at FundCalibre. And while the S&P 500 looks relatively expensive overall, if you exclude these seven companies valuations look more reasonable. The price/ earnings multiple on the S&P 500 index was around 21 times as of 8 November, according to Bank of America, but without the seven this figure falls to closer to 15 or 16 times earnings.

If you already have around 60 per cent of your portfolio in the US, you may not wish to add to it. But you could diversify within this allocation nonetheless. If you are giving thought to moving beyond the 60 per cent mark, for instance in order to stay in line with global equity indices, consider your overall portfolio and its aims. Such a move or just maintaining this level of exposure might not be suitable if, for example, you want a good portion of your portfolio in emerging markets for growth, are seeking income or have a lower risk appetite. 

In any case, because of the higher valuations on which the US market as a whole trades, Darius McDermott, managing director of Chelsea Financial Services, suggests making regular set investments in order to increase US equity exposure rather than putting in one lump sum. Investing a smaller, set amount each month means that when stock prices are higher you buy fewer units or shares, and when they are lower you buy more.

Less concentration

One way to reduce overconcentration in mega-cap technology companies is to take exposure to US markets via an equally weighted, rather than market capitalisation-weighted, passive fund. For example, the Xtrackers S&P 500 Equal Weight ETF (XDWE) tracks a similar number of holdings to market capitalisation-weighted S&P 500 tracker funds but weights the components equally – currently at about 0.2 per cent each – rather than by size. Its holdings are rebalanced to equal weights four times a year.

If you’re “unsure about big tech and current sector weights, moving to an equal weight strategy that places more emphasis on areas such as industrials, real estate, materials and utilities may be a consideration”, says Rob Morgan, chief analyst at Charles Stanley. “Broadly, the approach tilts towards cheaper value stocks and away from more expensive growth stocks."

However, the performance of US tech stocks this year underlines how different the outcomes can be for those who use an equally weighted fund: the Xtrackers ETF has significantly lagged the S&P 500 index since the start of 2023.

Another option could be an investment trust with substantial US exposure trading at a discount to net asset value. Baillie Gifford US Growth Trust (USA), for example, was on a 17.5 per cent discount as of 17 November. This is a way to “buy US equities with an implied discount”, says McDermott. The trust has a very different composition to the S&P 500 with only 69 holdings, 24 of which are unquoted and accounted for 35.7 per cent of its assets at the end of October. While it does hold plenty of technology stocks, among the big seven only Amazon, Nvidia and Tesla featured in its 10 largest positions as of 31 October, further differentiating it from the index.

Morgan says that you could also look to value shares which, as the name implies, trade on more reasonable valuations. Ways to do this include Fidelity American Special Situations (GB00B89ST706), whose managers take a more contrarian approach, aiming to uncover businesses that are unappreciated and therefore cheap. “The aim is to provide a margin of safety by buying into fundamentally sound companies below their true worth,” says Morgan. “To guard against value traps, stocks have to possess an identifiable long-term tailwind and not be part of a dying industry. [However, because its managers] eschew more expensive shares, the fund has almost entirely missed the rise of big tech over the past decade."

Morgan also suggests other active funds that take a distinct approach with little similarity to the broader market, such as Premier Miton US Opportunities (GB00B8278F56). Its managers can invest in companies of various sizes and, at the end of October, it had about 44 per cent of its assets in mid caps, 29 per cent in large companies and 27 per cent in small companies, according to Morningstar. Technology companies only accounted for 2.2 per cent of its assets.

The fund typically only holds 35 to 45 stocks, and its two largest holdings at the end of October were Graphic Packaging (US:GPK) and UnitedHealth (US:UNH), each accounting for 3.8 per cent of its assets.

However, while it has outperformed the S&P 500 over 10 years, it lags over five years and shorter periods due to its higher weights in smaller companies.

Morgan cautions that this fund and Fidelity American Special Situations “could also be a bit more dependent on the health of the economy and domestic consumption, so a deterioration here would probably do these strategies no favours. [But] to provide genuine diversification you often have to look to places where recent performance hasn’t been as good".

US equity income funds, meanwhile, have to buy companies paying good dividends, so tend not to invest as much in mega-cap tech. Areas of focus instead include industrials, healthcare and energy, and the funds typically focus on mature industries and provide exposure to more domestic, high-quality names. Examples of such companies include Johnson & Johnson (US:JNJ) and ExxonMobil (US:XOM), which feature in JPM US Equity Income’s (GB00B3FJQ599) top 10 holdings. These types of “companies may prove more defensive should the economy turn down", says Yardley. "The fund has a meaningful weight in the industrials sector, which could benefit if manufacturing revives.”

Smaller companies

Smaller companies have the potential to grow much faster than large-caps so can be a good option for growth investors with long time horizons. US smaller companies have not performed well against their larger peers over the past few years, but this means that they are typically not as expensive.

Options include Artemis US Smaller Companies (GB00BMMV5766), run by highly experienced manager Cormac Weldon. Ajay Vaid, investment research analyst at Square Mile Investment Consulting and Research, notes that Weldon's process "has proved successful across a range of market conditions”.

John Moore, senior investment manager at RBC Brewin Dolphin, highlights Brown Advisory US Smaller Companies (BASC). Its managers, Chris Berrier and George Sakellaris, aim to exploit market inefficiencies, and focus on businesses that generate durable growth, and have sound governance and scalable market strategies. At the end of October, its three largest holdings were Waste Connections (US:WCN), Casey's General Stores (US:CASY) and childcare business Bright Horizons Family Solutions (US:BFAM).

Another option is T. Rowe Price US Smaller Companies Equity (GB00BD446P55), which typically maintains broad exposure to both growth and value stocks.

Because of their higher risks, McDermott says that US smaller companies funds could account for just 10 per cent or so of your overall US equity allocation. So, for example, if 50 per cent of your portfolio is in US equities, 5 per cent could be in smaller and 45 per cent in larger US companies.