S&P 500 in bull market, but here’s why fund investors have missed out

Big Tech has propelled the S&P 500 into a bull market. But, as Kyle Caldwell explains, fund investors have not fully capitalised on the rally.

America’s S&P 500 index is back in a bull market, having risen 20% from a recent low point. 

A small number of technology stocks have propelled the index higher in recent months, those that are beneficiaries to advancements in artificial intelligence (AI). The seven stocks that have seen their share prices soar are:  Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), NVIDIA (NASDAQ:NVDA), Alphabet (NASDAQ:GOOGL), Apple (NASDAQ:AAPL), Tesla (NASDAQ:TSLA) and Meta (NASDAQ:META).

However, in most cases fund investors have not profited to the same extent from the rally. Data from FE Fundinfo, for the period 11 October 2022 to 12 June 2023, in which the S&P 500 index rose by 20.9%, shows that just seven US funds out of 251 in the sector, achieved returns above 20%.

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The reason is down to currency. Over that eight-month period, the dollar fell against the UK pound by around 12%. As a result, the assets held in US funds, which are priced in dollars, are worth less when converted to sterling for UK fund investors. 

Over the period, the average fund in the North America sector, which contains both active and passive funds, has returned 5.9%.

Two of the most popular passive funds to gain exposure to the US market – Vanguard S&P 500 UCITS ETF (LSE:VUSD) andiShares Core S&P 500 ETF (LSE:CSP1) – fared better, both up 8.2%. They hold the same stocks, and charge the same fee, which is just 0.07%. This works out at £7 on a £10,000 investment.

Such currency swings are highly unpredictable, and there will be times when the reverse scenario plays out. A recent example of UK fund investors benefiting from the dollar rising in value against the pound was when US stocks entered a bear market last June.

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The seven funds that managed to deliver 20%-plus returns, despite the currency headwind, were Xtrackers MSCI USA Information Technology ETF, Natixis Loomis Sayles US Equity Leaders, Invesco NASDAQ-100 ESG ETF, Invesco EQQQ NASDAQ-100 ETF, iShares NASDAQ 100 ETF, Fisher Investments Institutional US All Cap Equity ESG, and Invesco MSCI USA ESG Universal Screened ETF.

The S&P 500 entering a new bull market comes despite various headwinds, including rising interest rates, high inflation, and the possibility of a recession later this year or early in 2024.

Kristina Hooper, chief global market strategist at Invesco, notes:“Leadership has been narrow with a small number of tech stocks largely powering the rally. I think there are legs to this rally, given that FOMO (fear of missing out) is driving more investors into stocks right now, but I also believe there are potential potholes in the near term given uncertainty about Federal Reserve policy.”

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In addition, the US stock market is expensive, with various valuation metrics higher than its 15-year mean, according to data from fund manager Schroders.

For fund investors wanting to mitigate currency risk, some overseas funds come in special versions that strip out changes in the exchange rate. These versions, called “hedged share classes”, have identical holdings and the same fund manager. The difference is the currency hedging means that UK investors will see the same percentage rise in their funds as local investors, with no reduction or benefit from currency swings.

Such funds are not trying to call the market, the hedge simply aims to cut out currency exposure, good or bad.

Bear in mind, though, that hedging costs money, so annual charges on hedged share classes are typically 0.1 to 0.2 percentage points higher.