Richard Troue: America can be the brave new world just waiting for investors
Friday 29 March 2013
Of the major Western economies the US has experienced the strongest recovery. Perhaps this shouldn't be a surprise. The crisis began in the US. Its banking sector was the first to realise losses, house prices fell significantly and unemployment rose.
It was painful at the time, but the recovery process was able to begin sooner. The banking sector looks on a firmer footing. Mortgage lending is increasing and house prices are rising. Ben Bernanke, chairman of the Federal Reserve, has confirmed interest rates will remain low through 2014 and fiscal stimulus will continue until employment prospects improve.
It would be naïve to suggest the US has resolved all its problems. The government is spending too much and this ultimately needs to be brought under control. The recovery looks sustainable for now though. The improving housing sector could boost consumer confidence, while the wider economy could receive a boost from vast reserves of shale oil and gas.
As well as lowering fuel prices for consumers, businesses benefit from lower input costs. Coupled with a ready source of educated, skilled labour, which is keen to re-join the workforce, a revival of US industry could ensue as it becomes cost- effective to manufacture goods at home, rather than overseas. At the same time many US companies are capitalising on demand for goods and services from overseas, particularly faster-growing emerging markets.
The US is home to many large, well-known businesses that could be an investor's first port of call for exposure to the stock market. They tend to be so well-researched by analysts across the globe that it is difficult to gain an edge. Smaller companies on the other hand are less well-researched, making it easier to uncover a hidden gem, although it is a higher risk area.
The Legg Mason US Smaller Companies Fund brings the investment expertise of US firm Royce & Associates to UK investors. The company has over 40 years' experience investing in smaller companies. This fund is managed by Lauren Romeo, co-manager from launch in March 2004, and lead manager from May 2011.
The approach on this fund is the same as on the team's other funds. Company management must have a good track record of generating attractive returns from invested capital. They also like to see strong cash flow which can be reinvested to grow the business further or be paid to investors as dividends. Overly indebted firms are avoided in favour of strong balance sheets. Ms Romeo believes these characteristic make a business more likely to survive hard times and grow when the environment improves.
Presently she sees the US economy recovering and has not been afraid to add companies that could benefit. This has led to a bias towards technology, industrial and energy companies. Tetra Technology is a good example. It is a water usage consultant which has diversified from government contracts to helping commercial companies save water.
The team's focus on higher quality businesses tends to lead them to market leaders in their fields, while they also like those capitalising on international demand for products and services. Trican, for example, not only provides pressure pumping services to oil and gas firms in the US, it has operations in Russia and Central Asia. In the energy sector they prefer service companies such as Trican rather than exploration companies which tend to be more sensitive to swings in the oil price.
The fund's performance has suffered during the risk-on/risk-off environment of the past couple of years. Less exposure to defensive sectors such as healthcare and utilities afforded no protection when markets fell. Exposure to gold mining companies was also painful. The team admit they over-estimated the quality of management and failed to bring costs under control and turn a high gold price into higher profits.
The fund's long-term record remains strong. Since launch in March 2004 it has grown by 125 per cent compared with 114 per cent for the benchmark Russell 2000 Index. The fund is unlikely to offer protection if the US economy experiences further setbacks.
But it is managed by an experienced team who will continue to adopt a "plant and harvest" approach, using stock market weakness to top up favoured long-term holdings. It could be considered by investors who believe the US is on the road to recovery.
Richard Troue is an investment analyst at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit hl.co.uk
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