A defensive route into US stocks

The US stockmarket can be a tricky place to invest. But you’d be very foolish to ignore American equities completely. So what shuld you do? David C Stevenson explains.

There's a mountain of evidence to suggest that the US stockmarket is incredibly liquid, very efficient at day-to-day pricing and a perfect candidate for a passive investment strategy. There are some active managers who produce great results, but by and large trying to second guess who these might be in advance is probably a mug's game. Buy an exchange-traded fund (ETF) that tracks a major index, such as the S&P 500, the tech-centred Nasdaq, or the small-cap Russell 2000 index, and be done with it.

However, the American market can also be a tricky investment. Sometimes it becomes woefully overvalued, especially as global investors chase its top blue-chip global titans. At times like these, simply tracking the S&P 500 index might not always be the best tactic. Right now seems such a time. However, you'd be a very foolish investor completely to ignore American equities. So what to do?

The smart-beta solution

Ossiam Shiller Barclays CAPE US Sector Value Total Return ETF (LSE: CAPU)

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This uses a measure called the cyclically adjusted price/earnings (Cape) ratio, developed by US economist Robert Shiller, which measures the valuation of the market using average inflation-adjusted earnings over the past ten years, instead of current earnings. The idea is to even out the fluctuations caused by the economic cycle and provide a better insight into whether the market is cheap or expensive on a long-term view. The ETF adds a momentum twist to this, focusing on sectors that are cheap but whose price performance is improving.

The challenge with this approach is that value-orientated stocks don't always do well over a very long stockmarket cycle. Sometimes value stocks massively underperform, sometimes vice versa. But as a safety measure own American stocks, but only the cheapest sectors this could be an excellent idea.

Taming volatility

PowerShares S&P500 Veqtor ETF (LSE: SPVG)

The way that the underlying index for this ETF operates is a bit complicated, but broadly if market losses are greater than or equal to 2% during the previous five business days, it will move its entire allocation to cash. Unfortunately, the record of the index is concerning. In 2015 it crashed by 9%, but the S&P 500 index increased by 1.3%. In fact, in every year for the last five years the index has underperformed. So I think this may be one of those ideas that looked good on paper but doesn't work as well in reality.

However, PowerShares has another American smart-beta fund, the S&P 500 Low Volatility High Dividend ETF (LSE: HDLG), which looks more promising. This invests in the 50 stocks in the S&P 500 that offer the best balance between higher dividend yields and lower share-price volatility.

Funds news round-up

The asset-management industry has grown too large consistently to produce market-beating returns, according to Peter Kraus, a chief executive of investment house AllianceBernstein. "Our advice to the industry is to constrain ourselves. We are hurting ourselves by growing too big," Kraus tells Robin Wigglesworth in the Financial Times. He points out that the number of American mutual funds has more than doubled over the past two decades to 9,000, but "intuitively the number of talented managers hasn't doubled". At a certain point in the growth of a mutual fund, "the incentives shift from trying to outperform your benchmark to not wanting to underperform". Fund houses should consider capping the size of popular funds to ensure that size doesn't hold back performance, he says.

The investment management industry is "bankrolling" the campaign for the UK to leave the EU, says Attracta Mooney in the Financial Times. Almost half of the cash received by pro-Brexit groups has come from the investment industry, according to figures released last week by the Electoral Commission. Pro-Brexit groups received £8.2m in support of their cause between 1 February and 22 April this year, with an estimated £4m from the investment management sector. The majority of this came from Peter Hargreaves, founder of stockbroker Hargreaves Lansdown, who donated a total of £3.2m to the Leave.eu group.

David C. Stevenson

David Stevenson has been writing the Financial Times Adventurous Investor column for nearly 15 years and is also a regular columnist for Citywire. He writes his own widely read Adventurous Investor SubStack newsletter at davidstevenson.substack.com

David has also had a successful career as a media entrepreneur setting up the big European fintech news and event outfit www.altfi.com as well as www.etfstream.com in the asset management space. 

Before that, he was a founding partner in the Rocket Science Group, a successful corporate comms business. 

David has also written a number of books on investing, funds, ETFs, and stock picking and is currently a non-executive director on a number of stockmarket-listed funds including Gresham House Energy Storage and the Aurora Investment Trust. 

In what remains of his spare time he is a presiding justice on the Southampton magistrates bench.