Why investors overexposed to the US should think twice

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Most investors will have a sizeable weighting to the US stock market, particularly those who own global index funds or ETFs, which have weightings of around 70% to US companies. Some active global fund managers go against the crowd by holding less in the US, including James Harries of STS Global Income & Growth Trust Ord (LSE:STS). He explains why over a quarter of the portfolio is invested in UK shares, and runs through changes made to the investment trust during the stock market sell-off in April triggered by US President Donald Trump’s tariff policies.

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Kyle Caldwell, funds and investment education editor at interactive investor: Hello, and welcome to On The Money, a weekly look how to get the best out of your savings and investments.

In this episode, I interview a global equity income fund manager who holds less in the US than the wider global stock market. The manager is James Harries of STS Global Income and Growth investment trust. James explains reasons to be cautious about the outlook for the US market as a whole. However, he’s still finding opportunities in the US, and outlines some of his ideas.

James also explains why he’s viewing UK shares as an opportunity, and how he moved to take advantage of the stock market sell-off that played out earlier this year in response to US President Donald Trump’s tariff policies.

James, to kick off, could you explain why you are bucking the wider trend in running a global fund, or having around 20% less in US shares versus the global stock market, the MSCI World Index? Has this been a longstanding underweight position versus the index, or have you been reducing exposure to the US in more recent times?

James Harries, manager of STS Global Income and Growth Trust: So, there's a couple of things to be said about that. The first is, obviously, we run a global income and growth fund. There are, of course, high-quality yielding businesses in the US, but there are some very large businesses that don’t have much of a yield and are sometimes called the Magnificent Seven, but there are others.

Plus, you can say at the moment that the weighting of the US market within the global index is at a very high level relative to history, 70-ish per cent. So, in some respect, both those things count towards us being underweight that country.

The second point to make is if you looked at an MSCI high-dividend yield index, it would have a lower US weighting anyway, and so our weighting is probably a bit closer to that.

But having said all that, we are underweight the US, yes. We observe that the US is a higher proportion of the global market. It has been for a very long period of time.

It is very fully valued on long-term valuation measures such as a Shiller CAPE or market capitalisation to GDP, or similar measures. Therefore, it seems to us that you are facing a market that has pretty extreme valuation and pretty extreme concentration because so much of the index is in these very large non-yielding companies.

So, putting all that together, for us to be fulfilling our mandate, we think being underweight the US is a relatively sensible thing to be. I would also say that it is quite a longstanding position. We haven't been consciously reducing the US recently.

Because we’re in an unusual situation here currently where the US dollar is weakening, for lots of reasons, and we can talk about that.

Even at a time when markets have been a bit weaker, that suggests to us that there’s a change of trend in the US dollar. It may be that we get an opportunity at some point in the future to buy the best businesses, which tend to be in the US, in the best economy, which tends to be the US, in now a cheap currency and a really competitive economy. That’s a prize to be ready to take advantage of at some point in the future.

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Kyle Caldwell: You mentioned the approach. You’re looking to grow capital and also provide growing income as well. You touched on this, but does this mean you are then less wedded to having a big position in the US? Do you have sympathy for a global manager who typically do tend to have the US as their biggest country allocation, and many of them have around the index level of 70%?

James Harries: Well, it’s very interesting because if you go back in history, and you weren’t particularly that concerned about which benchmark one would use, if you looked at the MSCI World or the MSCI ACWI or the MSCI high dividend yield, they sort of tracked each other.

Recently, this phenomenon of whereby the main index has run away from other indices, particularly the high dividend yield index, is actually quite remarkable and is a function of the fact, of course, that we have these very large companies that have done particularly well, but which are now a very large part of the index, in some cases, really very fully valued. So, I think there is some sense anyway to diversifying somewhat away from that. I would also say that at Troy, we are not particularly benchmark-driven.

We want to be building a portfolio of high-quality global franchises, independent of a benchmark, with an absolute return mindset. We are trying to provide a particular return stream, if you like, for a particular cohort of investors.

What we observe, or what we believe, at Troy is that our investors tend to be those who have irreplaceable capital, and that tends to come in retirement, and in our case, are in need of income because people should, in my view, at least cover a proportion of their liabilities from income from their investments, so that when times are more difficult, they don’t have to dip into their capital at a time when they don’t want to.

So, you put all that together, and that means that we aren’t forced, if you like, to chase the index weightings in the way that others might be. It does also mean that we have had a tough time in the last couple of years and particularly since the technology companies have been doing so well.

But it would also mean on the flip side of that, if we do see a bit of weakness in that area, then we will do relatively pretty well, as well as fulfilling our mandate.

Kyle Caldwell: How challenging is it to look very different from the index? Is there an element of career risk? Of course, if you look very different from the index, then in theory, you’re not going to match it. You’re going to either outperform or underperform quite significantly either way, potentially.

James Harries: Yes. We like to think at Troy that we have a particular process and a particular way of doing things. We are known for investing in a conservative manner, for being very focused on valuation and quality, and on particular bits of the market that we think have sustainably high returns on capital employed and that are fairly predictable businesses that you can say something sensible about on a three, five, seven, 10-year view.

You’re quite right, that does mean that one looks pretty different from the index on occasion and that one’s performance can diverge quite markedly.

But we like to think, and, of course, time will tell, and that’s where career risk comes in, that people understand that and that they have in their portfolios lots of people who are doing the sort of investing that you’re talking about.

But they tend to hold Troy in that corner of their portfolio…we’re not going to make you rich, but we’re going to keep you rich. We should do well when times are more difficult and we have a particular type of return profile.

Kyle Caldwell: For a number of years now, the valuations attached to the US stock market have been at a pretty high premium compared to other regions. How do you assess valuations at the moment, and is this one of the reasons why you have this underweight position due to the valuations looking potentially too rich?

James Harries: The short answer is yes. Absolutely. So, we observe, as I mentioned, that the US market is really very expensive. Not just quite expensive, it’s very expensive by historical standards relative to its own history.

It’s also worth remembering that interest rates have gone up a lot. So, the market doesn’t just look expensive relative to its own history. It looks extremely expensive relative to bonds, relative to other asset classes. Therefore, we do think that it is potentially a time for caution.

There’s a broader point here also, that investors have done phenomenally well over, what, 15 years, 17 years? A really long period of time now.

Once again, for a certain cohort of investors, it might be really quite a sensible thing to do to take some of those, you might say, excess or supernormal gains and secure for yourself a robust and growing income stream from a global income and growth fund.

We would certainly advocate that, not for all your capital, but for a proportion of your capital that might be a very sensible thing to do. It is also the case, however, that there are other parts of the world that are not as expensive, and I would pick out the UK, oddly enough, as part of that.

We are underweight the US, as you say, but we’re actually overweight the UK. I would just mention that if you look at indices and markets and our portfolio, on an underlying revenue basis, the difference isn’t nearly as stark.

They all have about 50% in the US, we have about 50%. They all have about 20% in Europe, we have about 20%, and so on and so forth. So, at an underlying revenue basis, which is where companies actually make money, and is how we think you should think about it, we’re actually much less extreme as it would appear relative to the benchmark, and much more spread globally for a sensibly managed global income fund.

We don’t particularly, on that basis, invest geographically. We don’t think about so much where a company is listed, we think about where it makes money. But the UK is a bit of an exception because the UK has been in what you might describe as the capital markets’ doghouse for really quite a long period of time for all the reasons we know; Brexit, particularly, but for lots of other reasons. Therefore, it does oddly, geographically, idiosyncratically, look cheap.

It is also the case that the UK has had a history of paying decent dividends. You could argue in some respects that that’s been overemphasised at some points in the past, but it is the case that there are a number of high-quality global businesses listed in the UK, which have a nice return profile balance between capital and income, and which look idiosyncratically cheap. Therefore, we have been taking advantage of that.

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Kyle Caldwell: How much overall exposure does the investment trust have to the UK at the moment? And could you highlight some stock examples?

James Harries: So, we have about 30% in the UK. But once again, on an underlying revenue basis, we have about 6% in the UK. So, it’s really quite a dramatic difference in terms of the listing exposure relative to the underlying exposure, if you like. But we have a number of businesses that many people would be familiar with.

We have an investment in Unilever (LSE:ULVR). We have an investment in Reckitt Benckiser Group (LSE:RKT), which has had a troubled few years and therefore looks very inexpensive to us.

We have an investment in Admiral Group (LSE:ADM). Admiral is, we think, a very special business. It is probably the only proper UK business we own. But because they’re extremely good underwriters and they tend to be extremely adept at managing the insurance cycle, they make money in terms of underwriting. It might come as a surprise to many investors that most insurance companies don’t, actually. That enables them to then hand off some of their insurance risk to a much bigger company called Munich Re and retain the profitability. So, we think for lots of reasons, it’s a really special business.

So, there would be three good examples of global businesses listed in the UK. Well, the first two are global businesses, but three companies listed in the UK that look really good value to us.

Kyle Caldwell: And your investment style is seeking out quality growth companies. And, of course, you're also looking for good income growth as well. Could you outline the key characteristics that you're looking for when sizing up a new investment?

James Harries: Yes. So, we at Troy like to concentrate on particular businesses and particular sectors, and we like companies in which we invest to have identifiable and sustainable competitive advantages.

They relate to such things as brands to distribution capability, possibly to being the lowest cost, having potentially a regulatory arbitrage, whatever it might be, there are a number of nodes. Scale advantages is an important one, which enables companies to earn a better return than otherwise would be the case for a long period of time. That’s a critical point.

Within capitalism, as many know, if you earn high returns, then competition will come in and try and diminish them. Now these competitive advantages enable you to at least repulse that competitive threat for a period of time.

So, we want sustainable and unidentified high competitive advantages, which leads to high returns on capital employed and then to a degree of growth. Now the point about that is, and this is an interesting point, in recent years, growth companies and growth styles have done really well relative to income styles.

But, actually, if you look through history, it’s often the case that investors have a tendency to overpay for growth. The reason is because they’re the most exciting dynamic companies. They’ve got the newest mousetrap or the most exciting business model. But, of course, the return you generate from an investment isn’t simply a function of how fast a company grows. It’s how fast a company grows relative to expectations. It is often the case that people get overexcited about growth companies.

Whereas the sort of businesses we like, they grow persistently, but may not be the fastest growers and, actually, through time can produce a decent return without being the fastest grower. So, we want high-quality, good competitive advantages, an element of growth, but we don’t have to have the growthiest companies.

Kyle Caldwell: Earlier in the year, we had a pick-up in stock market volatility as the market became very wary about Donald Trum’s tariff policies. During that period, did you use that as an opportunity to take a good look at the portfolio and your watch list and then consider which companies had become cheaper in terms of their valuations? And, of course, the share prices may have also fallen as well.

James Harries: Well, that’s exactly what we did. We reduced some of the businesses that had held up particularly well, and we added to some of the businesses that, for whatever reason, had done relatively poorly, and, actually, that’s reversed fully now. So, that was a good decision.

We did also take advantage of the sell-off to establish a new position in Nike Inc Class B (NYSE:NKE), which was right in the crosshairs of what was going on at that point because Nike, of course, effectively sells trainers in the developed market and makes them in the developing market, particularly in Vietnam. That country had particularly, for whatever reason, punitive tariffs placed upon it, or it was suggested that it might.

Now this is after a couple of years, a period of time, when Nike’s had some quite serious strategic missteps. Effectively, to put it very simplistically, people were buying lots of footwear online during Covid, and Nike took that as a signal that people would be much more engaged digitally and much less likely to buy their trainers in a shop.

In fact, it turns out that people like to try on trainers when they buy them, and that was a bit of a strategic misstep. What it enabled competitors to do was come into their retail footprint and establish more of a presence than they had before. So, you’ve got a combination of some strategic missteps, a particular specific risk from tariffs, which meant that Nike was down over 70% from the high.

But this is Nike! This is one of the great global sportswear franchises. It has no debt, it is a fantastic brand. And we think that either by putting up prices to offset the tariffs, potentially moving some of the production elsewhere geographically to maybe circumvent some of the tariffs, but also get back to being the premier, global sports-led branded footwear and apparel business, is just a fantastic opportunity. So that was what we did.

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Kyle Caldwell: We've seen US and global stock markets recover their poise over the past couple of months. Both made steep losses early this year due to tariff uncertainty. However, those losses have now been recovered.

At the time of this recording in late July, the S&P 500 index is up nearly 9% year to date in US dollar terms. However, UK investors won’t have received that level of return due to the weakness of the US dollar, which has the effect of reducing returns for UK investors.

An S&P 500 index fund or exchange-traded fund (ETF) is up around 2% year to date for a UK investor. That, of course, is notably lower than the 9% return for the S&P 500 index in US dollars.

James, you touched on US dollar weakness earlier. Could you talk us through it? And do you think the US dollar will continue to weaken from current levels?

James Harries: It’s a very interesting question and it relates to the whole tariff question as well.

The proximate cause of recent volatility has been the tariff announcement by the US administration, but, of course, it should be put in context of a much broader picture.

We’ve been describing this as a “reverse Berlin Wall moment”. What I mean by that is when the Berlin Wall came down back in ‘89, it set up a whole chain of events which were very benign for the global economy, for capital markets, and so on.

What I mean by that is, effectively, the Iron Curtain came down. You had a huge flood of much less expensive labour coming to the global workforce. That meant there was structural downward pressure on inflation, structural downward pressure on bond yields. It meant that companies could optimise their cost base by sending manufacturing to a lower-cost area, and countries could optimise their comparative advantage, which is after all the classic economic idea, which led to fantastic returns all round, good growth and very little inflation.

Of course, that was sent into overdrive post the global financial crisis when not only did we have a very benign structural backdrop, but we also had interest rates go to zero and quantitative easing put in place. And that’s led to these wonderful returns.

We would argue that nearly all of that is going to reverse. So, globalisation, although we will still have a global economy, it’s quite clear that the global economy is bifurcating into a Chinese sphere of influence and a US sphere of influence.

It’s clear that policy can’t be as supportive in the future as it [was] in the past because interest rates are now no longer at zero, and fiscal policy is, at some level, constrained by the fact that government debt GDP is much higher across the board virtually than it was before that. Inflation is more of an issue.

It’s a much less secure world, so we’re going to have to spend more money on defence. Actually, you could say that that’s what tariffs are about. That’s encouraging countries around the world to say, are you with us or are you against us? That’s one element of the whole tariff regime, if you like.

So, we’ve had a number of things that have been the case for a long, long time that are going to reverse, and one of those is the dollar.

Traditionally, the US has seen the US dollar as an exorbitant privilege. It’s the world’s reserve currency that gives the US, frankly, slightly structurally lower interest rates than otherwise it would have, and real power within the global economy.

But more recently, they’ve seen it more as a burden and viewed it effectively as a cost to the US and [what] comes with it includes responsibilities to the rest of the world, both in terms of trade, but also in terms of security, which they are now, apparently, slightly less willing to stand behind. Plus, of course, the US financial position is far less strong than it used to be. Its international investment position is weaker, its fiscal position is weaker, and so on.

So, people are beginning to question whether the dollar is quite the thing that it used to be. Therefore, I think it is possible, even probable, that the days of a strong dollar structurally may well be behind us.

Now, that doesn’t mean that we won’t have periods of dollar strength. It just means that the trend from here, a bit like the trend of the US being north of 70% of the global markets has probably peaked and [ is in] a structural decline, the US dollar probably also is in structural decline relative to other currencies.

Kyle Caldwell: So, in terms of headwinds for the US stock market, there’s the weakness in the US dollar, which you’ve just explained, the fact that valuations are looking pretty rich, and also Donald Trump’s tariff policies. Which of the three do you think is most concerning?

James Harries: Well, the dollar to investors is a headwind, as you say, to a sterling investor. If the dollar is declining, then you’ll make losses. But, actually, to the US economy as a whole, a weakening currency can lend greater competitiveness. So, I wouldn’t say that necessarily.

I think the question mark’s over whether the dollar’s strength is what it was in the past are interesting and structural, and that is a bit of a risk.

I think tariffs are much more of an issue. The reason I say this is this. It goes back to the point that we’ve had amazing returns for a very long period of time. We haven’t really had a recession. We haven't really had a recession since 2000. We haven’t had one for 25 years because the global financial crisis was about leverage and banking, and that obviously had very dramatic consequences. But it wasn’t really an orthodox, normal recession, it was a banking crisis. And then we had Covid, which, of course, Covid was Covid. It was a very different sort of thing.

But an orthodox, classical economic cycle whereby you have a little bit too much inflation, so you put up interest rates to quell that inflation, which leads to a slowdown in the economy, which leads to a, usually, credit cycle, and therefore a reordering, and then we all go on for a lower level.

That looks pretty likely on the basis that we haven’t had one for so long, and there’s lots of these headwinds, which I’ve been describing, that have been building up. So, I think you could say anyway that [with] the US…the expansion was long in the tooth, the economic expansion, and valuations were very full.

So, you’ve got a fragile environment anyway, arguably, but then you come along and hit it with a hammer, which is tariffs. And it’s usually an exogenous shock, which often pushes economies from a slowdown into a recession.

Now I’m not saying it’s going to happen. I’m just saying the risks are definitely there. It’s so interesting that the US administration’s policies, there’s an irony within them, if you like, or at least there are positives and there are negatives.

The positives are that they are pursuing a deregulation agenda. They’re pursuing a tax-cutting agenda, which, unless it becomes a real fiscal issue, and we’ve talked about that a little bit, ought to inject some further growth into the economy.

But then against that, they have this protectionist [stance] and tariff policy as well as a harsher treatment of migrants, which means that the inward flow of people will be lower, which has an economic cost to it too.

It seems that the market is vacillating between concentrating on one and then the other. At one point, it’s looking at the tariffs, and that’s why we had the big sell-off, and then another time it’s looking at tax cuts from the ‘big, beautiful bill’, and has a bit of a recovery. So, we’re going to see this oscillation between the two, I think.

But overall, this combination of being late cycle, very fully valued, and having exogenous factors, which aren’t particularly helpful, is not a fantastic cocktail, if you like.

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Kyle Caldwell: And putting all that together, would you say that over the next decade, the returns for the US stock market will likely be lower than in the previous decade?

James Harries: Well, the maths would suggest that absolutely.

It’s interesting in a way that the market feels most optimistic when it’s most fully valued. But, of course, high valuations imply low returns as night follows day.

So, given where we are in terms of valuations in the US market, returns are extremely likely to be much lower in the next 10 years than they have been in the last 10 years, yes.

Kyle Caldwell: My thanks to James, and thank you for listening to this episode of On the Money.

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