SINGAPORE (Dec 11): It has been a banner year for the US stock market, but the majority of US equity funds registered for sale in Singapore have failed to beat the main benchmark indices. The few that outperformed did so on the back of exposure to fast-growing large-cap technology stocks.
Notably, the FAANG stocks — comprising social media giant Facebook, smartphone manufacturer Apple, e-commerce giant Amazon.com, digital entertainment provider Netflix and Google, whose parent company is Alphabet — are up between 28% and 51% this year. The Standard & Poor’s 500 and Dow Jones Industrial Average, which have been breaching all-time highs recently, are up 17.9% and 22.9%, respectively, this year. The Nasdaq Composite Index reached an all-time high of 6,912.358 points on Nov 28. It is up 25.9% in the same period.
According to Morningstar data, none of the 64 US equity funds registered for sale in Singapore beat the Dow Jones and Nasdaq indices this year. Only seven US equity funds beat the S&P 500. Among them is the Loomis Sayles US Growth Equity Fund, which returned 20.9% in the year-to-date period to Dec 4. Technology stocks accounted for 44.8% of its portfolio. Its second-largest allocation was in healthcare stocks, accounting for 15.7% of its portfolio. Consumer staples accounted for 12.9% of the portfolio. Its top three holdings are US-listed Chinese e-commerce giant Alibaba Group Holding, Facebook and Amazon.
Similarly, the BGF US Growth Fund A2 USD fund outperformed the S&P 500 with a return of 21.4%. However, it underperformed its primary benchmark — the Russell 1000 Growth index — which is up 26% this year. The fund’s largest allocation of 41.5% is in technology stocks, followed by consumer discretionary stocks, comprising 19.7%, and healthcare stocks at 13.9%. Its top three holdings are Amazon, software giant Microsoft and Alphabet.
By contrast, the Legg Mason ClearBridge Aggressive Growth Fund had 32.7% of its portfolio in healthcare stocks as at Oct 31. The technology sector was its second-largest allocation, comprising 24.5% of its holdings. Consumer discretionary and energy stocks accounted for 21.1% and 11.9% of its portfolio, respectively. Its top three holdings are biopharmaceutical company Biogen, healthcare insurer UnitedHealth Group and telco conglomerate Comcast. The fund returned a paltry 3.6% in the year-to-date period to Dec 4.
Portfolio manager Evan Bauman admits that the fund’s poor performance was partly owing to its underweight position in information technology stocks. He adds that the fund was also dragged down by its overweight position in energy stocks, the worst-performing sector, and certain media stock selections. “Our job as high active share managers is to own companies, not the stock market, [thus] there will be periods of time [when] we don’t correlate with the market,” he tells The Edge Singapore via email.
Similarly, the Parvest Equity High Dividend USA — (Classic EUR) fund underperformed the market with a return of 0%. The fund’s largest allocation was in financial services stocks at 28.2%, followed by consumer discretionary stocks at 14.2%. Technology stocks formed its third-largest allocation at 12.3%. Its top-three holdings are information management service provider Iron Mountain, industrial gases company Praxair and petroleum refiner Marathon Petroleum Corp.
River Road Asset Management, which manages the fund on behalf of BNP Paribas Asset Management, says the large-cap and growth stocks have “dominated” this year, contributing to the fund’s underperformance. The fund seeks to invest in US companies that distribute higher-than-average dividends.
“[Moreover], among stocks that pay a dividend, the lowest-yielding stocks — below 2% — have outperformed year to date. This proved to be a headwind as the portfolio invested in companies with yields in excess of 2% at the time of purchase,” say fund managers Henry Sanders and Thomas Forsha.
Will tech stocks climb higher?
One reason the FAANG stocks have rallied strongly is because they did not give investors any reason to doubt their ability to continue growing. For instance, Facebook recorded a 16% y-o-y growth to 1.37 billion daily active users on average in September. Its monthly active users also registered a 16% y-o-y growth to 2.07 billion as at Sept 30.
As a result, the company beat analyst expectations for 3QFY2017 ended Sept 30. Facebook reported a total revenue growth of 47.3% to US$10.33 billion ($14 billion), from US$7.01 billion a year ago. The company’s mobile advertising revenue accounted for about 88% of advertising revenue during the quarter. This is up from 84% of advertising revenue in the same quarter last year. Earnings surged 79.5% to US$4.7 billion from US$2.62 billion previously.
“[The third quarter] was another great quarter for Facebook. We saw continued growth and engagement in our community as well as strong performance in our ads business,” David Wehner, Facebook chief financial officer, said during the company’s results conference call.
Still, after the big run that they have enjoyed, some analysts fear that it might be too late to jump into the larger-cap technology stocks. In fact, some warn that their expanding market value has only drawn more money from passive funds. “We believe certain areas of the US equity market are becoming overcrowded, which has pushed up valuations,” says Bauman of Legg Mason. “For the [FAANG stocks], much of their advance has been led by continued money flow towards passive investing and less by improving fundamentals.”
However, Bauman sees value in some pockets of the technology sector. These include information storage companies Western Digital and Seagate Technology, which he notes are ramping up their exposure to high-growth cloud storage. He also favours chipmaker Broadcom, which is currently attempting to acquire rival Qualcomm. “We choose to own a number of companies that are trading at large discounts to the sector and the overall market,” he says.
Bauman says the Legg Mason fund continues to be overweight on the healthcare sector. In particular, he favours biopharmaceutical companies Biogen and Allergan for their undervalued status relative to their growth rates and pipeline potential. The fund is also overweight on the consumer sector, especially content developer Discovery Communications and Comcast. Bauman believes the value of these “underappreciated assets” will rise as merger and acquisition activity pick up on the back of increasing demand for high-quality programming and the need for scale.
On the other hand, Sanders and Forsha of River Road are seeing opportunities in the smaller-cap space. “Small- and mid-cap stocks have underperformed in 2017, so it would be reasonable to conclude that at some point, there will be a reversal of this trend,” they say. “We are a strong believer that over a market cycle, smaller companies tend to outperform large ones.”
US tax reform to lift all boats
The US stock market has been rallying strongly since the beginning of the year. It initially benefited from the surprise election win of US President Donald Trump, who had promised a big infrastructure spending programme and tax cuts. Then, continued improvement in economic data and corporate earnings helped keep the market on an upward trajectory.
Now, the market is watching out for progress on tax reform, potentially Trump’s first major economic initiative. Notably, the US corporate tax rate is expected to be reduced to 20% in 2019, down from 35% currently. On Dec 2, the US Senate voted 51 to 49 in favour of the Republicans’ tax-cut proposal. This comes following approval of the House of Representatives’ version of the bill last month. Both bills must now be reconciled to be approved by both chambers, before a single bill can be signed into law.
CMC Markets analyst Margaret Yang says the tax cut will not only boost corporate earnings significantly, but will also increase household spending and consumption by and large. “Once the positive feedback loop is formed, the economy will expand at an even faster pace and inflation will likely pick up too, resulting in rising interest rates. As a result, overseas capital will tend to flow back to the US, chasing for yield in the forms of investment and repatriations,” she writes in an emailed market commentary dated Dec 4.
Still, with the market already at elevated levels, things could unravel quickly. Sanders and Forsha point out that as the US Federal Reserve continues to hike interest rates, stock prices could be adversely impacted. The failure of the US Congress to pass the anticipated tax legislation could also spark a selloff, they add. Legg Mason’s Bauman says the rising geopolitical tensions in Europe and North Korea have caused recent spikes in volatility, which has been historically low in the last several years.
