Consumer-focused equities and shrewd stock picking could turn some North American investment trusts into winners in 2016, according to the experts.

Few managed funds have managed to beat the S&P 500 over the last five years but investment trusts have performed better.

Decision time

Now that the US Federal Reserve’s decision to raise short-term interest rates by a quarter of a percentage point has ended seven years of near-zero interest rate policy, and once the ripples of uncertainty that led up to the Federal Reserve’s decision to raise interest rates have calmed, investors in US equities should be able to look forward to a strong year ahead.

Fidelity’s Tom Stevenson says that while there will be some volatility in the markets, history shows that the overall response to a Fed rate rise tends to be positive for anyone with money invested in equities.

Stevenson says: ‘A look back at the past 30 years or so shows that the US stock market typically rises in the year that follows the first hike, as investors focus on the reasons why rates are rising - the improving outlook - rather than the impact of the tightening.’

Kully Samra, UK branch director at Charles Schwab, said that stocks that focus on the domestic economy and the US consumer are likely to do well in 2016.

‘The US economy continues to be the strongest in the developed world with GDP growth of nearly 2.5% predicted next year compared to just 1.4% in Europe.

‘The consumer makes up over 68% of the US economy, with the services sector accounting for 88% of GDP, which means that consumer-focused [sectors are] one of the most important areas to watch. So smaller company funds should could continue to do well.’

That is echoed by Dominic Rossi, Global CIO, Equities at Fidelity International, who says that with US consumers entering 2016 stronger than they have been in a decade, US consumption will easily weather a modest interest rate increase.

He says that as a result, 2016 should be a strong year for US equity investors: ‘The strength of the domestic economy leaves the US equity market better placed to cope with tighter monetary policy than other markets. This means that in US dollar terms, we can continue to expect the US market to outperform.’

Upside stateside

Harwood Capital’s North Atlantic Smaller Companies (NAS) and the JPMorgan US Smaller Companies Investment Trust (JUSC), which has been managed since 2008 by Don San Jose and his US-based team, both focus on smaller US stocks and are the top two performers among the very select group of specialist North American investment trusts over the past year.

On a one, three, five and 10-year basis the JPMorgan trust has outperformed the Russell 2000 index, and it has returned dramatically more than the S&P 500, too. It had a share price return of 11.7% over the past year and its price to net asset value is at a discount of 2.5%, compared to an average of 3.6% over the previous 12 months.

The fund’s management team seeks out companies that have a sustainable competitive advantage and also focus on owning equity stakes in businesses that trade at a discount to their intrinsic value.

Garrett Fish, who helps manage the JPMorgan American Investment Trust, says: ‘The Fed will undoubtedly be pleased by the initial market reaction to their relatively dovish language as they clearly wanted to avoid the complications that could have come from a spike in either the dollar or long-term interest rates. Their action marks a vote of confidence in the US economy and is likely positive for stocks, although we may see some short-term volatility.’

Fish, who has managed the investment trust since November 2002, says his focus remains on finding high quality companies.

He comments: ‘The US market is not in very expensive territory, innovation seems to be persistent and inflation seems to be subdued. Employment trends continue to show slow, steady growth and the cyclical areas of the US economy continue to improve from their depressed levels of a few years ago. Consumer confidence has also rebounded as consumers are more able to enjoy the benefits of this economic recovery.

‘We expect US growth to maintain momentum and for US equities to continue to provide a range of attractive opportunities.’

The trust has benefited over the long-term from its actively managed exposure to the broadly diversified US equity market. Its outperformance of the S&P 500 for much of the past decade has stemmed in part from the trust’s wide investment mandate to search out and invest in the best companies which are attractive from a valuation standpoint.

2016 outlook

Looking ahead to 2016, Fish adds: ‘With regards to our portfolio positioning, our largest overweight remains in the information technology sector. We find technology to be a fertile ground for stock picking, supported by its valuation and free cash flow.

‘We are overall optimistic on the technology sector, with a broadly diversified exposure to semiconductors, semi cap equipment, data processing and computer hardware.

‘Our main underweights are the materials and utilities sectors, as we are less excited about the long term growth prospects of both sectors as well as their unappealing valuation levels relative to other sectors.’

The bear view - ‘a canary in the coalmine?’

Investment trust analyst Alan Brierley from Canaccord Genuity Wealth Management is bearish about the outlook for US equities and by extension North American investment trusts. He says: ‘The US has carried global equity markets in recent years. The key question is how long will this last?

‘I’m intrigued by the disconnect between US equities and the high yield sector. While the equity market is close to all-time highs, high yield bond prices have plunged back to 2009 levels. Ominously, high yield spreads are at levels typical of recession. This does not bode well for the equity market.

‘I fear that the meltdown in the US high yield sector could be another canary in the coalmine. With US equity valuations at elevated levels, earnings growth anaemic at best (and facing strong dollar headwinds), and the breadth of market at historically narrow levels, this does not bode well for 2016.’