US shares’ role in a balanced portfolio

They have continued to be rewarded by the region’s strong performance, benchmarks having quickly recovered from the pandemic-induced market crash seen in February and March this year.

The US is home to the world’s biggest stockmarket, its biggest bond market and its reserve currency, while America is also the globe’s only real military superpower Russ Mould, AJ Bell 

In many cases, US indices have left other benchmarks trailing in their wake. As a result, some investors may have come to rely on US equities to power the growth portions of their portfolios. And it is not just returns alone that have encouraged them.

“The US is home to the world’s biggest stockmarket, its biggest bond market and its reserve currency, while America is also the globe’s only real military superpower,” says Russ Mould, investment director at AJ Bell.

“Throw in an entrepreneurial culture, a ‘can-do’ attitude and deep pools of capital, and the US has a lot going for it.”

US versus the world

The US’ dominance now also extends to global indices. As of 30 October 2020, the MSCI World index had a 66.8 per cent weighting to the US. The second largest country weight is to Japan, accounting for just 8 per cent of the index.

Pete Drewienkiewicz, CIO global assets at Redington, points out that as recently as January, the US was under 55 per cent of world indices.

It means that investors who believe they have a globally diversified portfolio of equity investments may well be far more exposed to US companies than they realise. At the same time, however, the enduring home bias of many UK clients’ portfolios suggests it is their UK rather than US positions that are increasingly out of kilter with other investors.

Concentrated exposure

Julian Cook, US equity portfolio specialist at T. Rowe Price, says: “There still seems to be relative inertia as it relates to US equities in balanced portfolios, despite the greater exposure to new economy industries and superior free cash flow performance.”

He adds that investors should be thinking more about being globally diversified, and that this “may well include a higher exposure to US equities, but also not to overlook other equity markets that have similar disruptive companies driving significant change”.

Ben Kumar, senior investment strategist at 7IM, takes a slightly different view. “As the US equity market dominates the global equity index at the moment, that is the biggest risk you’d wish to diversify away from.”

He says there are lessons to be learned from history, recalling that in the 1980s, Japan was the biggest equity market in the world, with the result that investors in ‘global’ equities ended up with half of their portfolio in Japanese stocks. 

“But then through the 1990s, Japanese stocks lost 50 per cent of their value, while world equities rose by more than 200 per cent,” he adds.

“The lesson to take is not that the US is going to crash in the way that Japan did,” Mr Kumar says. “The lesson is that concentrating all of your assets in one place can be very damaging. And at the moment, lots of global equity investors are doing just that.”

But how clients are invested in US equities at the moment will depend on their existing exposure, goals, risk appetite and the tenure of their investment outlook, according to Emma Wall, head of investment analysis at Hargreaves Lansdown.

“Because while the US market has appreciated considerably over the past decade, reaching yet new all-time highs this year despite macro headwinds, everyone needs some US stocks in their portfolio,” she adds. “Buying in now may not secure you a bargain, but that doesn’t mean you should sell out entirely either.”

Rebalancing portfolios

So what is an appropriate amount for clients to hold in US equities as part of a diversified portfolio?

Ms Wall says: “Dependent on whether you are looking for growth or income, and your risk appetite, US equities should make up between 20 per cent and 50 per cent of your equity allocation.

“Initiating that position now may be better done through active funds or stock selection, which can take a view on valuations, and then buying broad market exposure through more efficient passive funds on any market dips.”

Mr Drewienkiewicz says it makes sense for long-term investors, who are entirely focused on their own returns, to have a more diverse portfolio than the market-capitalisation weights.

This could mean increasing allocations to markets which have done less well recently, such as emerging markets, Japan, Europe, the UK, or even Chinese A-Shares, though he concedes that such moves aren’t “guaranteed to be a winning play”.

But even if investors do end up seeing a different kind of return profile from US equities in future, most agree it is important to maintain exposure to this asset class.

As Mr Mould says: “If the world stays mired in a low-interest-rate, low-inflation, low-growth funk, the US could well continue to outperform, especially as it is packed with tech and healthcare stocks.

“If we do get a cyclical recovery post-Covid of any note, other, more cyclical areas could offer better earnings growth potential and from a lower starting point in terms of valuation – Asia and to a lesser degree Japan, as well as the UK spring to mind.”

Ellie Duncan is a freelance journalist