Investors do not need to go down the passive route to beat the highly efficient US market, according to Rathbone’s Mona Shah, as a handful of actively managed funds have the ability to outperform.
Moreover, she believes that there are two compelling reasons why passive funds tracking the main US market could face significant problems in the future.
The US is often cited as an area where active management consistently struggles, because its status as the biggest market in the world means it is very closely covered and any new information is quickly priced into stocks.
The difficulty of active managers in outperforming the S&P 500 over both short and long periods of time is well known and frequently highlighted by passive advocates. Not only this, but exchange traded funds (ETFs) are far chea 
per than their actively-managed rival and can be traded in a more timely fashion.
So why is Shah (pictured) bullish on actively-managed US funds?
“Looking through markets down to sector levels is one of the reasons why not all of our US exposure is in passive. We’re looking particularly through to the sorts of sectors where the positive tailwinds behind the domestic consumer will have an impact,” she said.
The upcoming rate hike and the slowdown of QE are well-known headwinds to the average investor. As a result, is there an argument that the US market has run out of room for growth and has peaked already?
“Actually, we think that there are new tailwinds which mean we’re very positive on the outlook for growth in the US,” Shah explained.
“Particularly from US technology and healthcare – they’re the two sectors that we’re most positive on. With technology, we really think about it as replacing commodities as the key driver for equities on the input side into businesses.”
“Whether they’re manufacturing or service-oriented, you can replace people with robots or with software, or rather use the technology to help them to do a better job. For us that’s really positive for earnings.”
The Rathbone Enhanced Growth Portfolio fund, which Shah deputy manages alongside lead manager David Coombs, holds half of its top 10 holdings in American equities.
The fund takes a slightly higher-risk approach than others in Rathbones’ multi-asset range and seeks to achieve a return that is 2 per cent above its MSCI World/MSCI Emerging Markets composite benchmark.
Shah believes that the key to success when investing in the US is targeting the domestic economy, especially the consumer, rather focusing on international businesses. She argues that this rings truer than ever now that investors are finally seeing wage hikes in the US.
However, she says that it can be difficult to find funds which draw the benefits directly from this part of the market.
“When you look at the S&P 500, 40 per cent of earnings come from overseas. So what does that mean? It means you’re not getting that much exposure to the US consumer. So you have to go down the market cap spectrum,” she explained.
“Clearly most passive products are S&P 500, so that’s not really giving us what we want. We’ve been looking for rates or exposure to the consumer. The Russell 2000 has an 80 per cent exposure to domestic earnings.”
Shah and Coombs have been increasing their exposure to US small and mid-caps recently, in addition to seeking managers who are overweight in healthcare and technology.
An example of this is their top holding, the Clearbridge US Aggressive Growth fund, which they have allocated a 7.33 per cent weighting to.
The five FE Crown-rated fund, managed by Evan Bauman and Richie Freeman, holds 34 per cent of its portfolio in healthcare and 22 per cent in technology.
Over three years, Clearbridge US Aggressive Growth has achieved total returns of almost 94 per cent, which is 17.3 percentage points more than the Russell 3000 Growth Index and nearly 28 percentage points more than its average peer.
Performance of fund vs performance and sector over 3yrs
Source: FE Analytics
“Because it’s overweight these sectors, the earnings growth from that portfolio is much higher than the S&P 500 at large. The fund has performed well,” Shah said.
Another fund which she rates highly is Royce US Small-Cap Opportunity, managed by Bill Hench.
“We hold the Royce US Small Cap Opportunity fund to get better exposure to the consumer,” Shah said.
“When commodity prices started to fall and consumers started to feel a bit wealthier as a result in the US, the manager increased his allocation to US consumer retail. Notably, not online retail, but physical retail. The point is, if you’re driving to the mall and it costs you less to drive there because petrol is much cheaper, you might spend more money in store.”
The £1.2bn fund aims to achieve long-term capital appreciation by investing at least 70 per cent of its assets in a diversified portfolio of small and micro-cap US companies.
However, it’s not just the draw of the US consumer, healthcare and tech sectors that are pulling Shah towards actively-managed US funds.
She sees two significant risks in investing in US passive funds at the moment.
“The first one is the stronger dollar and the effect that’s having on earnings,” she said.
“Fourth-quarter earnings were disappointing but we see the dollar as continuing to be strong and so this will continue to have a headwind for large companies’ earnings where a lot of revenue comes from overseas.”
“The second one is liquidity risk. We’ve seen a glut of liquidity over the last few years and everything is pointing to that not being the case going forwards with the statements the Fed are making.”
Shah referenced recent research from Hermes, which dissected the Russell 2000 Index and broke down all the stocks by quality. Researchers found that the lowest-quality stocks over the last five years had in fact doubled the returns of the best-quality stocks.
“I was quite staggered by that. For me, that tells me that investing passively going forwards could be problematic if this quality dynamic unwinds.”