All eyes have been on US equities following last November’s surprise election victory for Donald Trump. The president ran his campaign based on a socially divisive but corporate-friendly agenda, and much of this was quickly priced into markets. But nine months on this is starting to unwind.
A promise of corporate tax cuts and the tearing up of regulation helped fuel increasing optimism over the US economy. Both US small- and large-cap indices had been rising steadily in the second half of last year, despite uncertainty over the election’s outcome. Following Mr Trump’s victory, the small-cap Russell 2000 index sprang into life, rising 13 per cent in three weeks.
However, aside from the immediate reaction to the result, US small caps have struggled to outperform larger US stocks. Over five years the Russell 2000 has gained 1.4 percentage points less than the S&P 500, but with a marginally higher volatility.
So unlike the UK equity space, the US small-cap segment may not be one where investors can turn for substantially higher returns.
Compared with UK equities, for example, over the same period the FTSE Small Cap ex IT index has more than doubled the rise of the FTSE 100, while the mid-cap FTSE 250 has outperformed the large-cap benchmark by 43 percentage points.
Similarly, fund selection is difficult. The sector contains 14 vehicles with a combined £6.2bn in assets under management, which have seen net inflows of £186m over the 12 months to July. Although the sector’s relative underperformance is not as severe as that seen for the IA North America group, the average fund has lagged the Russell 2000 over the past half-decade.
Despite being a small sector, the potential for significant outperformance from individual funds remains, particularly as markets become increasingly muddled. The Russell 2000 has struggled year to date in the face of a growing realisation that optimism may have been misplaced. It has lagged the S&P 500, gaining 7.4 per cent versus 11.5 per cent.
Seven months on from the president’s inauguration and the effect of politics dominating fundamentals is beginning to wane. Many believe the outlook for US equities, and in particular small caps, remains healthy – albeit not as strong as it would be were tax cuts pushed through.
Cormac Weldon, manager of the Artemis range of US equity funds, including its £182m US Smaller Companies vehicle, says given the lack of progress of Mr Trump’s healthcare reforms, tax changes this year seem unlikely.
He says: “The market is no longer discounting these tax cuts, so if they do come through they will be a bonus, particularly for smaller companies that tend to pay higher taxes.”
But he adds: “We have a positive view on the US economy in 2018 and believe that smaller companies offer better opportunities for growth.”
Goldman Sachs Asset Management has also supported the sector in its latest outlook, believing the unwinding of the ‘Trump trade’ had gone too far.
“With expectations so low, we think US equities now have upside potential on reform as any incremental progress on reform could be a positive surprise,” it adds.
THE PICKS
Artemis US Smaller Companies
This £182m fund, run by former Threadneedle manager Cormac Weldon, is one of the newest to the market, reaching its three-year anniversary later this year. Mr Weldon is top of the sector since launch, returning 76 per cent versus the Russell 2000’s 56 per cent gain and a 54 per cent average for the sector. Add to this Mr Weldon’s record at Threadneedle and his ability becomes difficult to question. The fund has benefited recently from positive sentiment around financials and technology, which when combined account for almost half of the fund.
T Rowe Price US Smaller Companies Equity
This Luxembourg-domiciled fund has amassed more than $1.1bn (£840m) in assets, with investors unperturbed by a change in management towards the end of 2016. Ryan Burgess took over the portfolio last October, having joined the US asset manager in 2007. The vehicle has struggled in the past year with a focus on consumer stocks and an overweight to energy. However, over three years the team’s process has worked, delivering 75 per cent compared with the 70 per cent rise by its Russell 2500 benchmark.
EDITOR’S PICK
Brown Advisory US Smaller Companies
This $281m (£214m) strategy is also based in Luxembourg and has been managed by Christopher Berrier since launch in 2007. The manager favours technology and industrial companies, holding almost a third of the portfolio in the former – a significant overweight. He has avoided the perils of energy with no positions in the sector. This allocation has paid off as the fund is the group’s top performer over three years, returning 82 per cent against the 67 per cent rise for the Russell 2000 and an average of 65 per cent by its sector. The vehicle has also outperformed both its index and peer group across five years.
