As the family's assets balloon, advisors should be on the lookout for fund overlap.
In a choir, it's important to have everyone singing from the same hymnal, but that isn't true when you're selecting funds for a portfolio.
Many investors take care to cover different areas of the equity and bond markets to help smooth out the ride as stocks and bonds move in and out of favor. To help do the job, clients and their advisors often turn to the offerings of American Funds. The past 10 years have seen enormous growth in assets at American Funds. In general, performance of the firm's funds has remained strong, but as American's funds have grown, we wondered whether there is now greater overlap between the funds.
To find out, we examined the correlation of returns between pairs of funds from separate Morningstar categories, using R-squared. We also compared those changes in correlation with the changes for broad Morningstar fund categories. Finally, we looked at the rise in foreign stakes at some of American's domestic-equity funds and how that has affected the way that they act relative to the firm's foreign- and world-stock funds.
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This exercise should help advisors avoid pairing those funds that look and act alike. It can also shine a light on the effects of the massive increase in assets at the funds; that increase may cause the funds to own more of the same stocks and employ more of the same managers (in order to spread the money around). It's important to keep any such changes in context, as the roller-coaster ride of the equity markets over the past 10 years has resulted in different types and sizes of companies becoming more attractive to managers of certain stripes.
More of the Same
First, let's tackle holdings overlap. We examined the overlap between each of American's three large-value funds--American Mutual
The biggest increase was between Washington Mutual and Growth Fund of America, from 3% of assets to 31%. Given the difference between the funds' objectives, that increase is rather eye-opening. Washington Mutual focuses on firms that pay healthy dividends and avoids those that garner the majority of their revenue from alcohol or tobacco. Growth Fund favors firms that churn out steady earnings growth or are in the midst of a turnaround.
Two developments help explain the funds' rising overlap and the increasing overlap between American's large-value and large-growth funds in general. First, after the late-1990s bull market run of growth stocks and value stocks' ensuing seven-year rally, valuation disparities between value and growth stocks have shrunk. There are fewer definitive bargains out there, so funds with different objectives--supported, to some degree, by the same analyst staff--are more likely to find the same stocks attractive. Second, there has been an influx of managers at these and other American funds. Because of the dramatic increase in assets, almost all of American's funds have more portfolio managers at the helm than they did 10 years ago. With more managers overseeing more assets, nearly every fund owns a greater number of stocks.