The US stockmarket has historically been a notoriously difficult place for active fund managers to add value through stock selection.

Larger corporations in particular are followed by so many analysts that opportunities to uncover anomalies or hidden gems are few and far between, and conventional wisdom holds that over the long-term index trackers can do as good a job as stocks at a lower price.

This is more obviously true for open-ended funds. No fund in the 89-strong IMA North American sector has beaten the benchmark S&P 500 index over one, three and five years (just one, Axa Framlington American Growth. managed it over three, five and 10 years).

In contrast, of the four trusts in the North America investment trust universe, three beat the S&P 500 over three and five years — although only one of them has managed it over the past 12 months as well.

The one ‘failing’ trust of the four over all periods, including 10 years, was the only passively managed fund in the sector — the former Edinburgh US Tracker. But — in response to its falling popularity when it inevitably failed to beat the index it followed — the Edinburgh trust has recently reinvented itself as The North American Income Trust (NAIT), with an active manager at the helm and a mandate to seek out dividend-paying companies.

That new focus on income is indicative of another, more pronounced sea change. Dividend payouts in the US have always been lower than in the UK and Europe, because US companies with spare cash have tended to reinvest it or buy back stock to boost their share price, rather than make direct payouts to shareholders. Thus, the focus of most US investment funds (closed and open ended) has, until the past year or two, been growth rather than income.

JPMorgan American: Benchmark-beating form

JPMorgan American (JAM), run by Garrett Fish and Eytan Shapiro, is the grande dame of the north American trust sectors, having been set up more than 120 years ago.

It is often said that it’s difficult for a large cap-focused trust to consistently beat the market. However, the trust’s share price has risen by 113% over 10 years, beating the S&P 500’s 85% gain. It has also beaten the index over five and three years, although (along with all its peers) it lags over 12 months.

JPMorgan American comprises two separate portfolios — one of large and medium-sized companies and one of small companies — with the option to gear. We don’t want to exclude small caps because that’s where the greatest growth prospects are. It has been shown that in small amounts small caps can improve overall performance and reduce risk, Fish says. The trust can therefore hold up to 11% in its small cap portfolio, though it currently has just 3% there, spread across 120 stocks.

Fish is not optimistic on the short-term investment prospects for the US, given the challenges of the fiscal cliff and government deficit, but his bottom-up stockpicking approach continues to throw up opportunities. Many companies he holds are globally-oriented S&P 500 firms and are in a position to earn international profits regardless of the current economic problems facing the US.

But The North American Income Trust is not the only player to shift its attention towards income generation. In October, BlackRock listed its new North American Income Trust, targeting a 4% yield after expenses.

Dividend drivers

Fundamentally, investors’ continuing quest for income sources in a low-interest rate environment has driven dividend developments, says Paul Atkinson at Aberdeen Asset Management. who manages The North American Income Trust.

Companies have a lot of cash on their balance sheets now, and directors are becoming more willing to distribute it to shareholders. Over the past five years, returns in the US have been more or less flat, so dividends are increasingly being recognised by companies as a way of improving total returns, he explains.

The US has considerable potential as an income proposition. Many US companies stopped paying dividends in the financial crisis, and payout ratios (shareholder dividends as a proportion of total net earnings per share) are still at 30-year lows — around 30% of earnings, compared with an average of nearly 40%.

That ratio is set to rise over time, given the $1.5 trillion (£936 million) of cash now sitting on companies’ balance sheets and the responsiveness of company boards to shareholder pressure, adds Atkinson.

Indeed, US dividend growth rates are among the highest in the world, at around 10% a year. Dividend payments used to be viewed as a sign that a company was not growing, but now they are seen as indicating financial strength, he says.

Scott Malatesta, a senior strategist at the new BlackRock trust, agrees: Companies paying dividends tend to be higher-quality companies with conservative balance sheets, run by management teams who are better stewards of capital.

Garrett Fish, manager at JPMorgan American, does not make dividend payouts a primary consideration in stock selection. However, he says: Income is important as a sign of corporate health and also very important historically for investors. Since 1926 dividends have accounted for 43% of S&P 500 returns.

There’s a strong sense, in short, that this interest in dividend income as an integral part of the US larger-cap investment landscape is no flash in the pan. Atkinson observes: Even if growth investing becomes increasingly fashionable, payout ratios are low, so companies should be able to fund both dividends and capital expenditure. Companies certainly won’t want to cut their dividends once they have set them, so I think it’s unlikely that companies will become less dividend friendly.

RENN Universal Growth: Focus on founder-owners

One trust that has not followed the income-seeking crowd is RENN Universal Growth (RUG). The trust, run from Dallas by Russell Cleveland, focuses firmly on growth areas in the US, specifically via small companies with founder-owner management.

The best US investments over the past 75 years have been in founder-owner companies, says Cleveland. He points to the trust’s largest holding, technology firm AnchorFree, which has been showing very rapid growth and recently won over Goldman Sachs (GS) as a major shareholder.

Nonetheless, RUG has a pretty mixed track record. Since inception almost 16 years ago, its net asset value has risen 270%, well ahead of the Russell

2000 (the trust’s benchmark index) at 187%. But Morningstar data shows that three- and five-year returns (in contrast with the other trusts in the North American smaller companies sector) have been negative — dire performance attributed by Cleveland to severe market declines and the revaluation of US Chinese holdings.

Over the past year, however, RUG’s fortunes have picked up. It beat all its peers with share-price growth of 23% over the year to 9 November 2012, while the discount to net asset value has narrowed from a high of 42% to 22%.

Cleveland is particularly interested in technology companies and medical technology.

However, he adds, some low-growth, high-yielding companies in sectors such as utilities might be revalued. But in the short term at least, the US’s government debt problems make the investment landscape a highly uncertain prospect and an economic slowdown likely.

Fiscal factors

The general feeling is that the fiscal cliff of tax increases — including tax rises on investor dividends — and spending cuts will be navigated one way or another. But Scott Malatesta says it’s likely to involve slow, tortured negotiation and higher volatility till a clear solution is in place.

A volatile market can, of course, provide good buying opportunities. Uncertainty gives us the chance to pick up cheap dividend stocks with relatively high yields, points out Atkinson.

Malatesta expects the solution to the fiscal cliff to involve a dividend tax rate increase, but he is optimistic that the rate will not rise to levels that are unpalatable for investors and that, against a continuing backdrop of low interest rates, demand will remain robust for dividends.

But the level of US government debt remains unsustainable in the medium term. Resolving this problem will involve a combination of spending cuts and tax hikes that are likely to dampen growth. With that in mind, Fish says: We continue to look for attractively valued companies that can expand their businesses in a very low economic growth environment.

One factor that could help these companies sidestep any slowdown in US growth is their focus on the larger-cap end of the market, where many companies have global reach. Fish holds a lot of companies where 35-40% or more of total returns are generated internationally.

Malatesta too has been looking for globally-focused businesses. We have found value in US-based companies with diverse revenue streams from global emerging markets, where economic growth is much more robust, he comments.

Ultimately, if the US economy slows, companies in defensive sectors, such as pharmaceuticals, telecoms and consumer staples, with cash on the balance sheet and an international dimension to their business, should weather a downturn — suggesting an income-focused investment could be a safer bet for US exposure looking ahead.