Will a Trump presidency make US active fund management great again?

January 20, 2017

Friday (20 January) sees the inauguration of maverick property mogul and reality TV personality Donald Trump as the 45th president of the United States of America and the de facto leader of the Free World.

Trump's rise to power has seen the financial markets flip rapidly from fear over what his volatile personality and protectionist instincts could mean, to bullishness over the potential impact on the US economy: a proposed cocktail of aggressive tax cuts, a shock and awe infrastructure investment programme, and reigning back on elements of banking regulations introduced after the credit crisis.

Notably, purchases of US equity funds proved more popular with UK retail investors, with net inflows into US equities funds of £168 million in November, a sharp reversal from the previous month when the sector saw an outflow of £224 million.

DOLLAR STRENGTH BENEFIT

Since Trump was named president elect in November the S&P 500 index of leading US company shares has surged 6 per cent, with UK-based investors in US equity funds also benefiting from a strengthening of the dollar against the pound.

While the precise details of which Trump campaign promises will end up being fully enacted remain a subject for debate, there is little doubt that US policy environment is changing dramatically.

The Fed has recently raised interest rates for only the second time since the global financial crisis and is expected to hike further during the year, and the new administration is clearly willing to adopt an aggressive approach to fiscal stimulus, though the scale of this is in doubt.

It seems evident that the zenith for globalisation has now passed, with the president-elect advocating an America First approach and talking of import tariffs and tearing up or renegotiating trade agreements.

Trump appears to favour a dealmaker's approach to trade relations, rather than one predicated on broad-ranging free trade agreement.

For investors who have already enjoyed a multi-year run just being in the US market, this radically changing policy landscape and what it implies for inflation, supply chains, global trade and corporate taxes opens up the prospect of significant differences between the potential winners and losers from these seismic shifts in policy.

This, laced with prospect of Twitter-led diplomacy, creates the prospect for high levels of future volatility as well much greater dispersion in returns between stocks and sectors.

THE CASE FOR ACTIVE MANAGEMENT IN THE US

In theory this should create a much more fertile investment landscape for those active fund managers prepared to take a much more selective approach.

In recent years they have increasingly been regarded as almost redundant when it comes to investing in US equities, in favour of low-cost index trackers.

The S&P 500 index has long been a notoriously tough index to beat, but in the aftermath of the global financial crisis when the market has been supercharged by a tide of liquidity and the low cost of capital has fuelled share buybacks, the benefits of cherry picking which companies to own has simply not paid off for the vast majority of funds.

89 per cent have underperformed over the last five years up to Trump being named president-elect.

This has cemented the reputation of the North American fund sector as the graveyard of active fund management and understandably prompted many investors to choose index funds instead.

But we are moving into very different times and it may just be the case that more discerning approaches start to pay off. First, I would caution against getting swept up in the current market euphoria based on short-term sentiment.

The US should certainly be a key market for long-term investment exposure, representing 53 per cent of the global market-cap as measured by the FTSE World index and home to many leading global businesses.

But as a short-term trade, a lot of optimism is now factored into US share prices, which are standing at premium valuations compared to history.

UK investors contemplating making new investments into the US on the back of Trump-mania, should think carefully about whether this is the right time to be buying when the pound is at such a weak exchange rate versus the dollar.

TRUMP BENEFICIARIES

Existing investors, who have done so well, should considered whether they now have too much exposure to the US and whether it might be sensible to lock-in recent gains by trimming their holdings back, or switching some of their positions into funds that take a more selective approach or have a greater emphasis on company valuations.

A traditional passive approach, which has worked so well during the multi-year bull market, and remains relevant for long-term buy-hold-and-forget investors, may not prove to the be the 'no brainer' bet we've all become used to in the medium term, given the potentially very divergent fortunes for business and sectors ahead.

And a possible wildcard outcome could be an improvement in the fortunes of US active fund managers after years in the wilderness.

The beneficiaries of the Trump agenda, as far as we understand it, appear to be businesses with a combination of either:

  • high exposure to domestic US earnings, which should therefore be more insulated from the damaging impact on international competitiveness of the strong dollar and uncertainties around trading relationships
  • businesses with low staff costs as a percentage of revenues given an anticipate rise in wage inflation
  • firms likely to benefit the most from planned corporate tax cuts

At the sector level the Trump victory has been positively received by financials, energy companies and businesses that might benefit from infrastructure investment, but considerable risks persist for companies with high exposure to emerging market trade or supply chains given continued sabre rattling towards China.

But Trump's unpredictability has the capacity to destabilise stocks and sectors. This was recently demonstrated by his comments that healthcare companies are 'getting away with murder' in what they charge for medicines, comments which spooked the share prices of biotech and pharma companies.

They had initially reacted positively to his election, seeing it as a respite from Clinton's threat to implement greater price controls.

HOW TO INVEST IN THE US

Here are four ideas for accessing the US market that do not involve a traditional market-cap weighted passive approach:

Dodge & Cox Worldwide US Equity

Dodge & Cox Worldwide US Equity invests in a portfolio of US companies and is managed from San Francisco with a team approach and with a strong value-style bias, which could stand it in good stead when concerns remain about the premium valuation of US equities.

The fund currently has a sizeable weighting of 29 per cent in financials, almost twice the exposure of the S&P 500 index, with prominent holdings in Bank of America, Wells Fargo, Capital One, Charles Schwab and Goldman Sachs.

T Rowe Price US Smaller Companies Equity

If you buy into the Trump narrative and believe he will succeed in ratcheting up domestic growth, then funds focused on smaller companies, which are typically more domestic in nature, could benefit the most.

T Rowe Price US Smaller Companies Equity, managed from Baltimore, is highly diversified with 192 positions and has been adding exposure to gas utilities, energy exploration and regional banks.

Old Mutual North American

Old Mutual North American is managed using a systematic investment approach that weights the potential universe of stocks based on the attractiveness of their valuations, the strength of their growth characteristics, market momentum, analyst sentiment and management attributes.

This disciplined approach is used to construct a portfolio of around 200 holdings, which currently has 22 per cent exposure to IT and 16 per cent to financials as major themes.

PowerShares FTSE RAFI US 1000 ETF

Investors who just cannot bring themselves to give active US managers a second chance might instead consider this exchange trade fund over a traditional S&P 500 tracker.

It invests in a basket of the 1,000 largest US companies, but instead of weighting them on market-capitalisation, stocks are weighted based on a basket of four fundamental factors: book value, cash flow, sales and dividends; and this is rebased annually.

This approach leads the portfolio to be weighted to more robust companies and with a tilt towards more reasonably valued businesses.

Jason Hollands is managing director at Tilney Bestinvest.

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