US funds sector review – inflation, interest rates and what it means for investors

In March, the US Federal Reserve (Fed) raised interest rates by 0.25% after inflation hit 7.9% in February – a 40-year high. The rate rise was widely anticipated by the market and further rate rises are expected in the coming months.

Interest rate rises increase the rewards for savers looking to earn interest on their cash, but make it more expensive for consumers and businesses to borrow money.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, please ask for financial advice.

Is the central bank behind the curve?

Inflation has been climbing in recent months. The 7.9% figure for February is a lot higher than the average inflation target of 2%.

Rising energy and food prices have contributed to the headline rate increase and are an unwelcome squeeze on incomes. Both are essential spending so lots of consumers will probably have to cut spending elsewhere. Of course, some will feel the squeeze more than others – lots of American workers lost their jobs during the pandemic.

Looking forward, the Fed will be hoping that rate rises will help to disperse some of the pricing pressure in the economy and bring inflation closer to its target. Markets will be hoping for the same. Inflation is unsettling because it can erode a company’s profits and, ultimately, investor returns.

Rising uncertainty

The Fed will want to bring inflation down without knocking the growth of the American economy off course. The central bank has already downgraded its growth expectations for the US and now expects growth of 2.8% in 2022 and 2.2% in 2023.

The obvious uncertainty and expected global supply chain disruptions caused by Russia’s invasion of Ukraine also don’t help growth prospects. Commodity prices and crude oil have spiked as companies and countries look to recalibrate their energy supplies to reduce reliance on Russian exports. The longer the war continues and the deeper the sanctions imposed on Russia, the greater the potential for a growth hit.

Investing in these funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

What have the research team been up to?

In the last few months, we met a number of US fund managers, including Cormac Weldon, manager of the Artemis US Smaller Companies fund. Weldon has almost 20 years’ experience of investing in the US and uses a clear, disciplined investment approach. The fund features on the Wealth Shortlist.

Find out more about Artemis US Smaller Companies, including charges

Artemis US Smaller Companies Key Investor Information

We also met with Rui Cardoso, co-manager of BA Beutel Goodman US Value. The fund launched in November 2020 and the managers look to invest in quality companies with strong balance sheets trading at a discount to their true value.

The managers have remained disciplined through a tough period. They’re optimistic about the opportunity set with a portfolio they see as trading at a discount to its true worth.

Find out more about BA Beutel Goodman US Value, including charges

BA Beutel Goodman US Value Key Investor Information

Remember all investments fall as well as rise in value, so you could get back less than you invest. For more details on each fund and its risks, please see the links to their factsheets and key investor information below.

How have the US Wealth Shortlist funds performed?

The strongest performer out of our Wealth Shortlist selections over the last year has been the Legal & General US Index fund, gaining 17.43%. This was marginally behind the FTSE USA Index which returned 19.09%. Past performance is not a guide to future returns.

The fund uses a full replication approach which means it aims to invest in every company in the FTSE USA Index and in the same proportion. Despite this, tracking errors can occur meaning the fund delivers a different return to the index.

Over the long term, we expect its return to fall behind the index rather than be ahead because of the costs involved in running the strategy, like taxes and dealing charges.

Tracking difference vs. tracking error – what investors need to know

The weakest performer over the past year was the Baillie Gifford American fund. Over the last year the fund hasn’t performed as well as the FTSE USA Index or the IA North America peer group average.

Some of the fund’s investments in companies that did very well as a result of the pandemic have been more of a drag on performance in the last 12 months. That’s reversed some of the gains of the year before.

More recently the managers’ growth-focused investment style has fallen out of favour with investors. That’s mainly because of inflation and interest rate expectations rising. Investors have been less willing to pay up for companies with high growth potential which has seen stock prices of some the fund’s investments fall.

We’ve been engaging with Bailie Gifford on the fund’s performance. Although short-term volatility can feel uncomfortable, investors should focus on the longer term. This fund aims to perform better than its benchmark over a five-year period. But the fund’s style means performance can look quite different over shorter periods.

We don't expect all the funds on the Wealth Shortlist to perform in the same way. We think it's important for investors to build a portfolio filled with managers who have different approaches and investing styles to help generate long-term returns.

Past performance isn’t a guide to the future. Source: Lipper IM, to 28/02/2022.

Find out more about Legal & General US index including charges

Legal & General US index Key Investor Information

Find out more about Baillie Gifford American including charges

Baillie Gifford American Key Investor Information

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Our fund research is for investors who understand the risks of investing and that investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.