Out of favour and fashion, but the US is still crucial

American markets have performed badly, but there's still value around, says James Daley

The US has been out of favour with UK investors over the past few years – and it's not hard to understand why. With a weakening dollar and deteriorating economy, there has been little to commend the US market to the average punter. This week, things lurched from bad to worse, as Bear Sterns became America's equivalent to Northern Rock. Meanwhile, fears continue to mount over who might be the next unexpected casualty of the credit crisis.

Other developed markets, such as the UK, have looked far more attractive as investment destinations. Britain has proved much more resilient to the economic headwinds, and does not involve the currency risk that comes with investing in the US. Since the bottom of the last bear market in 2003, the S&P 500 index of leading US stocks has risen by around 50 per cent. However, for UK investors, this works out at closer to 30 per cent, once the deterioration in the value of the dollar has been taken into account. And there's no indication that this situation will improve any time soon. The US Federal Reserve has slashed interest rates by a whole 3 percentage points, from 5.25 to 2.25 per cent, over the past six months – further weakening the dollar.

However, Felix Wintle, the manager of Neptune's US fund, believes that concerns about the dollar are overblown. Although a further deterioration in the value of the currency may work against UK investors, the effects are incredibly positive for US exporters: their products are that much cheaper.

"It's a point that's often misinterpreted by UK investors," he says. "I often get asked, 'Why should I put my strong pound into a weak dollar fund?' – but if the companies you're investing in are benefiting more from the weak dollar than you are losing, then it's a good investment."

Although Wintle admits that it's a tough market at the moment, he believes there are plenty of good-quality stocks that will continue to prosper in the current climate.

"There's lots of reasons to be positive about the US, particularly when one compares it to other geographies in the developed market universe," he says. "It's so broad and deep, so you have access to many different sectors and sub-sectors that simply don't exist in other developed markets.

"Parts of the market are relatively unaffected by what's going on the US at the moment – those that are not US-facing, and whose customers are in the Gulf states or China. There's an awful lot of money flowing around in these regions."

Wintle proudly reveals that his portfolio has not held a US bank for almost two years. Instead, he has been focusing on the industrial and minerals sectors, as well as the oil services and tobacco sectors, where he believes there are good long-term prospects.

Among his favourite stocks is Potash Corp, the world's largest producer of fertiliser ingredients such as nitrate, phosphate and, of course, potash. The boom in demand and shortage in supply of food products is helping to push up demand for fertiliser; Wintle believes this will continue over the coming years.

He also likes some parts of the energy industry, such as oil services companies, which produce the drilling and exploration equipment for oil companies. "With oil at $110 a barrel, no one's going to want to stop trying to find and drill new oil wells," he says. "But the industry has now moved to a deep-sea focus, as this is where many of the remaining untapped sites are, and this requires much more complex technology and equipment." He picks FMC Technologies as one of his key holdings in this sector; he also adds that he has bought into Coca-Cola, attracted by its powerful global brand.

Scott White, of the Edinburgh-based fund management group Martin Currie, agrees with Wintle, arguing that the sheer size of the US market means that there are still some great bargains to be found. Martin Currie's recently launched North American Alpha fund – an aggressively managed, unconstrained US fund – makes the point. Between its launch on 19 November and the end of February, the fund managed to grow by 4 per cent, during which time the overall market fell by 2.8 per cent. Unlike Wintle, the Martin Currie team have even dabbled in the financial sector over that period, investing in the institutional fund management group State Street, which was up more than 8 per cent during the first three months since the fund's inception, as well as the insurance company Assurant, which was up 4.4 per cent. They also bought into the solar energy support group MEMC, which has leapt more than 25 per cent since last October.

Although the short-term outlook for domestically focused US companies continues to look somewhat bleak, the sharp market drops of the last few weeks have encouraged a handful of observers to express cautious optimism that the worst may soon be behind the US – at least in terms of negative stock-market sentiment.

"Given the market falls we have already seen, we are well over 75 per cent of the way through 'normal' recession bear markets," says Paul Niven, the head of asset allocation at F&C Investments. "Risk-appetite measures now show that equity investors are in 'panic' territory, and valuations are becoming increasingly compelling, with many markets' relative valuation metrics entering the most attractive levels since the start of the recent bull market.

"Markets will be volatile, but the repricing we have already seen leads us towards expecting a moderate rebound in equity markets over coming months. From this perspective, we would caution against panic and capitulation, as such sentiment is already evident from the majority of market participants, and instead take a degree of comfort that a variety of asset classes are already discounting a bearish outcome."

Another catalyst for the good may be the forthcoming US elections. With the electorate as fired up and engaged as they have been in years, Wintle suggests that the November vote itself may have a broadly positive effect on markets. While there was once a risk that the election of a Democratic government (which currently seems the most likely option) might spark a negative reaction from investors fearing a swathe of interventionist policies, both Barack Obama and Hillary Clinton have laid out their stall as free-market capitalists – meaning that a change in government could trigger some mild market euphoria.

Even if you're not yet ready to take a big bet on the US, it may be worth keeping a small slug in your portfolio, to provide some additional diversification. For help finding a financial adviser in your area who can help you build a balanced portfolio of investments, visit www.unbiased.co.uk.

The Stateside funds to look at

*James Davies, the head of research at Chartwell, the Bath-based financial advisers, says that finding a North American fund that is going to outperform over the long run can be particularly difficult.

"The US equity market is very efficient, so it's very hard to outperform," he says.

Nevertheless, he believes investors would still do well to allocate a small amount of their portfolio to the market, to help their diversification.

"The United States is still the world's biggest economy," he says, "so you want some exposure to US markets."

One of the cheapest ways to get a piece of the US action is to buy an exchange-traded fund (ETF), such as Barclays S&P 500 ishare. ETFs trade like regular shares, but they, effectively, track an index, and cost much less than an actively managed fund.

If you are looking for an active manager who can potentially offer you some better performance, however, James Davies recommends M&G's American fund, which has returned around 45 per cent over the past five years, compared to an average of just 25 per cent.

*Philippa Gee of Torquil Clark, financial advisers, says she likes the M&G American fund too, and she also picks out Martin Currie's North American funds. Alternatively, for investors looking for income, she recommends Jupiter's North American Income fund.