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Lifting the Curtain on Changes at American Funds Bond Fund of America

Recent changes to this fund's portfolio manager structure shows much tinkering going on.

Janet Yang, CFA, 05/17/2012

American Funds Bond Fund of America ABNDX has transformed itself in recent years. While we've been following these changes closely--disappointing results in 2008 caused the firm to strategically shift away from corporate bonds toward more government-backed offerings--the fund's recently released prospectus, as well as meet­ings with the team, has shed new light on just how they've been going about it.

First, some background: Longtime investors and observers may recall that for much of its history, BFA tended to lean more toward credit-sensitive and corporate fare than many of its peers. Until 2007, corporate and high-yield bonds often made up about two thirds of the portfolio, with mortgages and government bonds taking up the balance. That focus on corporate bonds was a natural outgrowth of the firm's equity research and its emphasis on bottom-up, fundamental company research. After all, corpo­rate bonds are just another rung on a company's capital structure.

It did, however, lead to a few stumbles along the way when taking credit risk proved to be a liability. (For example, the fund lagged the vast majority of its peers in 2002 and 2008.) In response, in 2009 American strategically shifted the allocation in BFA so that corporate bonds--both investment-grade and high-yield alike--took up far less of the portfolio. BFA is now about evenly divided between corporate, mortgage, and Treasury/agency bonds--an allocation that's closer to the Barclays U.S. Aggregate Bond Index's. The move should make the firm's flagship bond fund (at $33 billion, it's also the fourth-largest in the intermediate-term bond category) more of an all-weather choice and likely better able to handle credit shocks.

More Than Meets the Eye
However, a number of changes to the manager roster and subsequent meetings with the firm reveal that the fund's reconstitution has entailed more than simply shifting assets among sectors. (Figures 1 and 2 illustrate the change in BFA's manager structure in the past few years.) American has started to set stricter guidelines for the fund and its managers, somewhat curtailing the independence that has typically been a hallmark of the firm's equity offerings.

- source: Morningstar Analysts

In the past two years, five new managers have joined the team. In early 2011, high-yield specialist David Daigle replaced David Barclay. (Barclay remains with the firm as a portfolio manager on a number of other strategies. The other portfolio manager to leave during that time, Mark MacDonald, retired in 2011.) Daigle's appointment also roughly coincided with a policy shift on high-yield bonds. Before, Barclay focused mostly on high-yield bonds, but any of BFA's portfolio managers could also hold high-yield securities. Now only Daigle is allowed to do so. The other managers must either sell him any of their holdings that get downgraded to high-yield status or liquidate those positions over a few months.

At the same time, emerging-markets specialist Rob Neithart joined as a named manager on the team. While other managers in the group can hold investment-grade emerging-market bonds, in practice, Neithart holds the vast majority of the fund's allocation. (Its emerging-markets exposure remains capped at 5.5% and currently stands at about 4% of the fund.)

The fund's move toward these two specialist manag­ers acknowledged the volatility that even small amounts of high-yield or emerging-markets bonds can play on an overall fund--it's a lesson that a number of other managers also learned following 2008's rocky markets, and it should help when taking credit risk becomes a liability again. Still, for a firm that heavily touts and relies on its fundamental credit research capabilities, it was disappointing that the fund also got burned in 2008 by significant holdings in investment-grade bank bonds, some of which were crippled by their subprime-mortgage exposure.

Janet Yang is a fund analyst with Morningstar.

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