An Already Good International Fund Just Got Better

The following is our latest American Funds Europacific Growth A AEPGX

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A structural change strengthens American Funds Europacific Growth’s already deep and talented investment team, earning its cheapest share classes a Morningstar Analyst Rating of Gold, while its pricier shares are rated Silver.

The strategy’s additional resources bolster its case. American Funds’ parent Capital Group previously split the asset base between two equity subsidiaries. Then in January 2020, the firm added its third equity subsidiary, Capital International Investors, to the management roster, tacking on two new managers and roughly 50 additional supporting analysts. Eleven managers supported by approximately 150 industry analysts now steer this strategy through the international equity universe. Capital Group’s characteristic multimanager approach, whereby each manager has complete discretion over their own slice of the portfolio, explains the vast management team and grants investors access to several tenured and skilled investors.

The change eases some capacity concerns. Granted, the fund’s roughly $160 billion asset base makes it the second-largest actively managed equity strategy, as of July 2020. Its size also prevents managers from taking meaningful stakes in smaller-cap firms. Still, no manager controls more than 10% of assets, mitigating key-person risk and damping the impact of manager changes. Further, the mix of independent investors plying differentiated investment approaches adds diversification. CII’s addition bolsters this diversification and adds resources commensurate with the fund’s size and mandate.

Though the fund’s 7.7% annualized return over the past decade through August 2020 merely edged the MSCI All Country World Index ex USA Growth, it topped the MSCI ACWI ex USA by 2.4 percentage points. To be sure, the strategy has more closely followed the former of late and fits squarely in the foreign large-growth Morningstar Category. Still, it outperformed most peers in 2016 when value stocks trounced their growth counterparts. In all, this bustling strategy has its nuances but remains stellar.

Process | Above Average This strategy has grown to an extraordinary size over the years, but, other than reducing the percentage of assets devoted to smaller stocks, the overall approach has remained largely intact over the years. The freedom allotted the experienced managers and the adept combination of styles results in an Above Average Process rating.

American's multimanager approach lets managers independently run their own sleeves of the portfolio. Each uses his or her own style, and their combination fulfills the fund’s growth mandate while adding diversification. The managers don't shy away from risk: Emerging-markets stakes are usually relatively high, and occasionally individual managers will put a large allocation into one or a few stocks.

The managers’ investment styles range from concentrated growth to more-diffuse, value-oriented strategies, though high portfolio turnover is frowned upon. The fund’s annual turnover is typically 25%-35%, reflecting the managers’ long-term perspective. Below-average turnover also helps keep trading costs in check. Large analyst staffs support the managers with investment ideas and industry-specific analysis. A portion of the fund is devoted to an analyst-run research portfolio, too. This mix of independently managed portfolios across the international equity universe forms a broadly diversified portfolio.

People | High A multimanager structure enables this fund to handle its massive asset base. Its High People rating reflects the managers' experience, tenures at the firm, and success, and the depth and tenures of the large analyst staff.

Capital Group, the parent of American Funds, has split the fund’s massive $160 billion asset base--the largest in the foreign large-growth category--between equity subsidiaries Capital World Investors, Capital Research Global Investors, and Capital International Investors since January 2020, when the firm added CII to the management roster. Carl Kawaja heads up the whole fund and CWI’s team, which includes Jonathan Knowles, Andrew Suzman, Lawrence Kymisis, and Lara Pellini. Christopher Thomsen guides CRGI’s team of Sung Lee, Jesper Lyckeus, and Nicholas Grace, while CII’s Gerald Du Manoir monitors his and Noriko Chen’s portfolios. The managers each oversee a separate sleeve of the portfolio, with Kawaja, Thomsen, and Du Manoir helping to ensure that their investing styles complement each other. Pellini is the least experienced member of the management team but still has 18 years of experience, all with Capital Group. The CII, CWI, and CRGI teams each draw on about 50 analysts. Each analyst group also oversees its own slice of the portfolio.

All 11 managers invest at least $100,000 in the strategy, with four investing over $1 million.

Parent | High Capital Group is a model steward in many respects and merits a Positive Parent rating. More widely known in the United States for its American Funds lineup than in the rest of the world, the active manager boasts very reliable equity and allocation offerings. The firm's multimanager system drives its success. Dividing each fund into independently run sleeves lets managers invest in line with their styles, enhancing diversification and reducing the overall portfolio's volatility. The funds' analyst-led research portfolios help develop the next generation and recruit top talent with the promise of running money from the start. The result is an investment culture marked by lengthy tenures, strong manager fund ownership, and competitive long-term records.

Capital's efforts to bolster its fixed-income operations are bearing fruit. It now has the tools to compete with the best bond shops, and the talent. It has added six veteran managers since 2015, including Pramod Atluri, who was nominated for Morningstar's 2019 Rising Talent award.

Capital aims to unbundle distribution from investment management, which should play to its strengths as a low-cost active manager. Still, it has yet to disentangle all its clean shares from revenue sharing. With its lineup expanding globally, Capital should also clarify its approach to capacity, including what would cause it to close a strategy to protect current shareholders.

Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category's second-cheapest quintile. Based on our assessment of the fund's People, Process and Parent pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Silver.

Performance The strategy has delivered solid long-term results. The A shares' 6.6% annualized return during the trailing 15 years through August 2020 beats the MSCI ACWI ex USA (its chosen benchmark), the MSCI ACWI ex USA Growth, and the average for the foreign large-growth category, where it currently resides, all by meaningful margins. And its return has topped the foreign large-blend category average (the fund had been in that group until late 2014) by more than 2 percentage points. With the fund's huge asset base, it's important to note that it has performed well in recent years, too, though not quite as impressively versus growth comparisons in a growth-friendly climate.

Performance in the last two downturns, however, has been wanting. First, when international equities dropped from Jan. 29 to Dec. 24, 2018, the fund’s 24.0% loss was 2.4 percentage points more than both the core and growth benchmarks. Most recently, the fund’s 32.6% tumble in 2020’s novel coronavirus-driven sell-off, though less than the core benchmark, was deeper than the growth index’s 30.3% loss.

The strategy has done well in recent market rallies, though. The fund’s robust 54.0% rebound off March’s lows through August 2020, for instance, topped the growth and core benchmarks by 2.9 and 8.6 percentage points, respectively.

Portfolio The strategy's independent sleeves combine to produce a deep portfolio. As of June 2020, the strategy counted 338 names with roughly one fifth of assets stashed in the top 10 holdings. While certain managers may concentrate their sleeves, the top stock in the portfolio currently takes up less than 3% of assets.

This large portfolio has distinctive positioning, though. Its stake in tech firms has ranged from 11% to 21% over the past five years, versus the MSCI ACWI ex USA's 7%-12%. This posture contributes to the strategy’s growth tilt relative to the core index.

There have been notable regional deviations, too. The managers have generally favored emerging markets, including Indian banks like HDFC and Kotak Mahindra in the strategy’s top-20 holdings. The strategy’s India positioning has absorbed 7%-9% of assets over the past five years, versus roughly 2% for the index.

With approximately $160 billion in assets, the fund is the foreign large-growth category’s biggest offering. Assets are down from their peak of $171 billion in November 2019, but the fund's girth limits its ability to take big positions in mid-cap stocks. As of June 2020, the fund’s 62-basis-point position in PagSeguro PAGS, then a $16 billion Brazilian payments firm, absorbed more than 8% of the company’s outstanding shares, close to the fund’s own internal 9.5% cap.