For many years, the US equity market has delivered robust growth, particularly in AI, technology, and communications sectors. These sectors have contributed to a significant portion of the returns in certain US indices, largely driven by just a few dominant companies. In our view, this has created some concentration risk with simply having exposure to the US via indices. At the same time, the US economy remains strong, with consumer sentiment high and a domestic focus moving forward. Given these dynamics, we have reevaluated our US equity exposure in order to navigate this evolving economic landscape effectively and made some fund changes to reflect this.

Historical Investment Approach

Over the past few years, we primarily relied on index-based investments for US equity exposure due to the structure of US equity indices. These indices are market-capitalised, meaning that as the largest companies—primarily in the technology sector—grew, their influence on index performance also expanded. This approach delivered excellent returns with minimal need for active management.

However, with concentration risk so high, we believe there is currently opportunity in under owned areas of the US market. These under owned areas are below long-term averages from a valuation perspective. There are opportunities to invest in very high quality stocks which are cheap because they are being ignored due to large amounts of money being allocated based on market capitalisation indices.

Our research suggests that diversifying away from index-based exposure and employing active managers with high tracking error and positive alpha strategies will offer the best potential for returns. These managers will focus on concentrated portfolios, ensuring that every holding contributes meaningfully to performance rather than relying on a few large stocks.

Implementation of Changes

To realign our US equity strategy, we have replaced market-cap-weighted index funds with two actively managed funds:

Smead US Value Fund

• A value-oriented fund with a large-cap bias, focusing on undervalued yet high-quality companies.
• The fund’s active approach mitigates risks of value traps and capitalises on market inefficiencies.
• Managed by a long-tenured team dedicated to a consistent value-investing approach.

GQG US Equity Fund

• A growth-focused fund investing in high-quality companies poised for sustained returns.
• Active selection ensures exposure to the best opportunities within growth sectors.
• Managed by an experienced team following a disciplined, repeatable investment process.

Combining these two funds allows us to maintain a balanced exposure to both growth and value investing, reducing volatility and enhancing long-term return potential. There will still be exposure to the magnificent 7, just not as concentrated as if we were to remain in the indices.

Increasing Exposure to US Small and Mid-Cap Stocks

In light of the recent US election and the policy direction of the new administration, we identified additional opportunities in the US small and mid-cap (SMID) sector. Historically, these stocks have lagged behind large-cap stocks due to factors like higher interest rates and economic uncertainty. Despite interest rates starting to ease and economic conditions improving, small and mid-cap stocks continue to be significantly undervalued. Coupled with the ongoing deglobalisation of supply chains, which benefits companies more exposed to the US economy; government initiatives aimed at growth; and regulatory advantages that could disproportionately favour smaller companies, the SMID space presents an appealing investment opportunity.

Reallocation Strategy

To fund this increased exposure, we have reduced our holdings in UK small and mid-cap stocks. While both the UK and US have undergone political shifts, we believe US policies—focused on deregulation, tax reductions, and domestic economic growth—will create a more favourable environment for small-cap companies. Additionally, US small and mid-cap stocks benefit from greater liquidity and broader economic resilience compared to their UK counterparts. The size of US Small cap market and the average stock size is as big as UK FTSE 100 companies.

Key Drivers for US Small and Mid-Cap Investment

1. Valuation Opportunities: US SMID stocks are currently trading at a -25% discount to large caps, historically a strong buy signal.
2. Earnings Growth Potential: Forecasts indicate a sharp earnings rebound in 2025, with expected growth of 40% compared to -7% in 2024.
3. Market Positioning: Unlike large caps, US SMID indices have not yet reached all-time highs, signalling further growth potential.
4. Interest Rate Sensitivity: With a higher proportion of floating-rate debt, SMID stocks stand to benefit more from potential declining interest rates.
5. Market Broadening: A shift in market dynamics suggests greater participation from a wider range of stocks, reducing reliance on a handful of large-cap names.

Active Management in US Small and Mid-Caps

Given the complexities of the small and mid-cap space, active management is essential. Risks such as unprofitable businesses and value traps necessitate careful selection by experienced managers. By focusing on profitable, high-growth companies while avoiding weaker performers, active managers can unlock significant upside potential.

We have therefore added the Federated Hermes US SMID equity fund.

• Managers specialise in investing with a quality growth style within SMID cap US equities
• Focusses on future fundamentals rather than backward focussed metrics.
• Sector agnostic
• Managed by a long tenure team of investing in SMID caps in the US

Conclusion

With evolving economic and political conditions, we believe our changes made a few weeks ago was an opportune time to refine our US equity strategy. Our key adjustments include:

• Moving from index-based exposure to active management.
• Balancing growth and value investing through specialised fund allocations.
• Expanding exposure to undervalued US small and mid-cap stocks.

These strategic shifts position our portfolios to capitalise on emerging opportunities while managing risks associated with market concentration. We remain committed to delivering superior long-term returns through active management, ensuring our portfolios are well-positioned and diversified for the future.