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How American's Putting Cash to Work

How cash stakes of some American funds have declined, and what the managers of those funds are buying.

John Coumarianos, 12/07/2009

American's equity funds often have held healthy cash positions. Of course, because of the multiple portfolio counselor system, the aggregate cash position of a fund is the result of many disparate decisions of the underlying counselors. Those cash stakes, however, can also help avoid problems that fund flow issues could cause--having to sell stocks to meet redemptions, for example--while also allowing the counselors to pounce on opportunities when they arise. Holding cash both as ballast and as an option on future bargains is a strategy many value investors employ.

Based on our analysis of recent regulatory filings, some American Funds now have decidedly lower cash stakes than they have had in the past. In other words, the counselors running the funds may be "exercising their options" and buying stocks at what they think are cheap prices. This is understandable, given that 2008 was a horrendous year for the markets and that stocks were arguably very cheap in early 2009, despite problems in the financial system and the economy at large.

One might have expected the market's fierce bounce back since March 2009 to deter some of American's counselors from continuing to buy stocks, it doesn't appear to have discouraged all of them. Like many American Funds' counselors, Warren Buffett recently bagged the "elephant" he'd been looking for by purchasing Burlington Northern BNI for Berkshire BRK.B. (Capital Group, parent of the American Funds, happens to be the largest institutional owner of Burlington Northern.)

However, not all of American's funds have decreased their cash stakes. Some have increased or maintained their cash stakes.

In this article, we'll take a look at how cash stakes of some funds have declined, and discuss what the counselors of those funds are buying. We'll also look at other funds that have maintained hefty cash stakes.PAGEBREAK

Where Cash Stakes Are Declining

American Funds AMCAP AMCPX
American Funds AMCAP, our newest Analyst Pick in the large-growth category, is one of the American's most flexible funds. Although it's primarily a stock fund and tends to find its home in the large-growth square of Morningstar's style box, it has the ability to invest in convertible preferred stocks and cash. It also has among the highest concentrations of mid-cap stocks of American's funds. As recently as September 2008, the fund's cash stake was 14.4%, while its bond stake was another 2.5%. For much of the past three years, the fund's cash stake exceeded 10%, and reached as high as 17% at the end of 2007.

Now, by contrast, AMCAP's cash stake is under 7%, and it has almost no bond exposure. Among its biggest stock additions before Sept. 30, 2009, were initial positions in office supply retailer Staples SPLS, insurer Aetna AET, and credit card processor MasterCard MA and a large addition to Bank of New York Mellon Corp BK.

American Funds American Mutual AMRMX
This fund seeks three things that are hard to combine: current income, capital growth, and conservation of principal. Additionally, its task is burdened by the fact that it doesn't own tobacco and alcohol stocks, some of which can be high dividend payers. To meet its three-pronged objective, it has typically invested in a mix of common stocks, nonconvertible preferreds, U.S. government bonds, investment grade corporate bonds, and cash. The fund finds its home in the large-value square of the Morningstar Style Box.

The fund's cash stake clocks in at just under 7%, according to the Sept. 30, 2009, portfolio, whereas it has had more than 10% stock exposure in almost every other published portfolio over the past three years. Its cash exposure was also nearly 14% at the end of September 2008.

However, while AMCAP appears to have reduced its cash stake in favor of stocks, American Mutual has favored the bonds of U.S. Government agencies, such as Fannie Mae FNM and the Federal Home Loan Bank of Atlanta, and various corporate bonds. Indeed the fund's bond exposure is 9.4% currently, which is higher than it has been for most of 2007 and the first half of 2008, when it never approached even 4% of the portfolio.

American Funds Washington Mutual Investors AWSHX
Another Analyst Pick with a reduced cash stake is American Funds Washington Mutual Investors. This is the American fund with the strictest dividend mandate. The fund seeks income, growth of capital, and preservation of capital. It derives its income primarily from common stocks and securities convertible to common stocks, but also owns smattering of nonconvertible preferreds, U.S. government securities, corporate bonds, and cash. Like its sibling American Mutual, this fund avoids alcohol and tobacco stocks.

Washington Mutual's cash stake is 0.50% of the portfolio, while it was often more than 3% of the portfolio for the past three years. The fund has recently initiated positions in Duke Energy DUK and Dow Chemical DOW, and added substantially to its third-largest holding, Verizon Communications VZ. Although it had solid exposure to financials in recent years, its current sector overweights are in telecommunications, utilities, business services, and industrial materials.

American Funds Investment Company of America AIVSX
This large-blend stalwart is running with about 9.4% cash now, down from the 12%-15% stake it had over most of the past three years. This fund's mandate is to provide long-term growth of capital and income, but unlike Washington Mutual, it places a greater emphasis on future dividends rather than current income. The fund also differs from Washington Mutual in that it can also own alcohol and tobacco stocks. It invests in common stocks, but it can also hold investment grade bonds, nonconvertible preferreds, and cash.

Like American Mutual, Investment Company of America has purchased the loans of Fannie Mae and the Federal Home Loan Bank of Atlanta recently. It has also added to its position in French energy firm GDF Suez, railroads Union Pacific UNP and Burlington Northern, and Abbott Laboratories ABT.

Where Cash is Still Heavy, if Not Quite King

American Funds New World Fund NEWFX
The American Fund equity fund with the largest cash stake is American Funds New World. This is the shop's emerging markets fund, and it traffics not only in stocks domiciled in emerging markets, but also in stocks domiciled in developed markets that do a lot of business in emerging markets. So Latin American telecommunications firm America Movil AMX rubs shoulders with Swiss food giant Nestle NSRGY in this portfolio. Finally, the fund tends to hold some emerging markets bonds as well. These factors give it a decidedly tamer profile than the typical emerging markets fund.

The fund has roughly 15.5% of its assets in cash now. Over the past three years the fund's cash stake has ranged from around 17% to around 7%. The fund's counselors appear to have had the lowest cash stake at the end of 2008, which probably caused some pain in early 2009, but ultimately gave the fund greater exposure to a furious emerging markets rally during the rest of the year.

American Funds Growth Fund of America AGTHX
Unlike its growth sibling AMCAP, Growth Fund of America continues to have a significant level of cash-around 12.6%. The fund owns some of the loans of Fannie Mae and Federal Home Loan Bank of Atlanta in addition to the commercial paper of Abbott Laboratories, Bank of America BAC, Procter & Gamble PG, Microsoft MSFT, and Yale University.

On the stock side, the fund has added to investment bank Credit Suisse Group CS, soft drink behemoth Coca-Cola KO, and telecommunications infrastructure firm Qualcomm QCOM. Because of the fund's size, it's difficult to find a significant position that has been built quickly.

Among the most significant sales was computer and mobile phone maker Apple AAPL. The firm sold nearly 3 million of its nearly 19 million shares in the third quarter of 2009.

Making Sense of the Moves
Collectively, these changes to the funds' cash positions may be a wash, but the buys and sells illustrate the counselors' long-held practice of buying stocks in periods of weakness and selling into strength. Several of the counselors' biggest adds, including Staples, MasterCard, and Abbott Labs, are trading with price/earnings ratios below their industry averages and have strong financials. The loans of Fannie Mae and the Federal Home Loan Banks also look cheap, according to fund managers we've spoken with lately. On the flip side, slimming down on Apple, a darling of 2009's rally that has more than doubled in price, is a classic sale into strength.

John Coumarianos is a mutual fund analyst with Morningstar.

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