Putting Together an American Funds Portfolio

How should investors make use of the biggest fund family around? American Funds has a fairly compact fund lineup--excluding its target-date funds, it offers just 15 equity funds--yet investors still have decisions to make. Should they choose one or two of the firm's world-stock funds, or combine its domestic-stock funds with its sole foreign-stock option,  EuroPacific Growth  (AEPGX)? I'll review four portfolios recently featured in the American Funds newsletter.

While American runs fine offerings on both the growth and value sides of the style box, as well as all-U.S. equity funds and more wide-ranging options, many of its funds overlap with one another. There are two reasons for this. First, as the firm's stock funds have grown ever larger: Many have added more managers to the mix, and thus they have more holdings than they previously did. Because each manager is using research from the same pool of analysts (and granted, it's a large staff), it's inevitable that some of the analysts' favorite stocks will appear in a number of funds. Also, the valuation discrepancy between growth and value stocks has become compressed in recent years after the massive disparity apparent in the bull-market peak of early 2000, and many of American's funds are investing more heavily in lagging mega-caps--which are a relatively small group. Thus, the firm's growth and value funds have more holdings in common than before. For example, large-growth behemoth  Growth Fund of America  (AGTHX) and large-value offering  Washington Mutual (AWSHX) had only 7% of their holdings overlap at the end of 1999; that figure rose to 31% by June 2007. (I measured overlap in the most conservative fashion--if one fund held a 2% position in  General Electric (GE), for example, and the other had a 1% stake, that counted for 1% overlap.)

The overlap issue is one reason why I think a relatively simple portfolio is the best way to go for many American Funds investors. Of course, the concept of a simple portfolio is appealing for another reason, too: Investors have fewer funds to track. Also, another plus for keeping it simple is that you're less likely to end up with some sort of overpriced index fund. Without further ado, let's get to the portfolios.

Portfolio 1
 Fundamental Investors  (ANCFX),  Capital Income Builder  (CAIBX)
This portfolio combines an adventurous fund (large-blend offering Fundamental Investors) with a more staid one, world-allocation fund Capital Income Builder. Both are among my favorite American funds. Fundamental Investors' managers are free to invest in an opportunistic fashion (there are no dividend requirements), so it owns both value and growth plays, as well as a hefty stake in foreign stocks. Also, at $52 billion, it's one of the firm's smaller equity funds. Capital Income Builder is a behemoth at $114 billion, but it owns both stocks and bonds from all over the world that offer hefty yields, and the underlying firms have solid balance sheets. The two funds have relatively little overlap, just 18%. This combination is a bit on the conservative side, in a sense; a 50/50 split between the two funds results in a 12% cash stake and another 10% in bonds. The foreign stake of this portfolio would be about 40% of equities in a 50/50 split--that's higher than the typical recommended weighting, but I think such an allocation, while it subjects the portfolio to more currency swings, provides more exposure to the growing number of strong businesses outside the United States.

Portfolio 2
 Amcap  (AMCPX), Washington Mutual, EuroPacific Growth
This portfolio combines American's most pure play on large-cap growth stocks (Amcap), its most appealing large-value fund (Washington Mutual), and its only broad foreign-stock fund. The overlap between Amcap and Washington Mutual has grown over time, from 19% in mid-2005 to a recent 26%, but Washington Mutual's dividend-focused mandate keeps it from wandering far into growth territory. It's also worth noting that Washington Mutual, at $89 billion, is quite large, but the fund's longstanding focus on mega-caps mitigates liquidity concerns. Also, it's run by seven of the firm's most experienced skippers. Of more concern is EuroPacific's bulging $129 billion asset base--it's more than twice the size of the next-largest foreign-stock fund. That said, the fund hasn't had to add a portfolio manager to its lineup in five years, and continues to generate solid results. When the three funds are combined equally, the portfolio's cash stake is about 10%. (Many of American's equity funds hold a cash stake in the high single or low double digits). About a third of the portfolio's equities are based outside the U.S.

Portfolio 3
Amcap,  Income Fund of America (AMECX), EuroPacific Growth
A modest variation on the portfolio above, this one replaces Washington Mutual with moderate-allocation fund Income Fund of America. Like the fund it replaces, this one's equity portfolio is tilted heavily toward dividend-paying value stocks, but it's less blue-chip-oriented. The fund also includes a fixed-income sleeve that holds a hefty slug of high-yield bonds. Thus, the fund pays out a healthy income stream. And, just 5% of its portfolio overlaps with Amcap. Like Portfolio 1, this one, when the funds are held in equal proportion, has nearly a quarter of its assets in cash and bonds. The portfolio's foreign stake is 44%.

Portfolio 4
 New Perspective  (ANWPX), Washington Mutual
This is another very simple combination of funds with a lot of fundamental appeal. New Perspective is a world-stock fund that tends to buy companies when they're down and out, then lets its winners run for the very long term. (Thus, the fund often tilts toward the large-growth style box.) The two funds have just 16% overlap between their portfolios. When the portfolio is split 50/50 between the two funds, just under a third of its equity weighing is in foreign stocks. Rounding Out the Portfolio

Rounding Out the Portfolio
The combinations above are quite basic; many investors may want to add two important areas to their portfolios to varying degrees, based on their risk tolerance: bonds and smaller-cap stocks. American's bond shop is not as accomplished as its equity side, but I'm increasingly impressed with it due to some gradual changes there. (I detailed these changes in the April 2007 issue of the American Funds newsletter.) The most wide-ranging offering is Bond Fund of America: Although this newsletter has been skeptical of the fund in the past, I think its prospects are improved as more resources and personnel have been devoted to it. On the small- and mid-cap side, I think investors are best served by looking past American's lone offering, the enormous  Small Cap World (SMCWX), to more flexible choices. Some of those include U.S. stock funds such as  Columbia Small Cap Value II (COVAX) and  Masters' Select Smaller Companies  , and foreign-stock funds like  Columbia Acorn International  (LAIAX) and  T. Rowe Price International Discovery  (PRIDX).

How Does the New Competition Stack Up?
In February 2007, American Funds launched a series of target-date funds. These are funds of funds that intend to be one-stop shopping options, and they grow more conservative over time as they reach the investor's intended retirement date. I took a closer look at the most equity-heavy of these offerings, American Funds Target Date Retirement 2050 (AALTX), and compared it with the four portfolios above. Because American has only one smaller-cap fund, the target-date fund's equity sleeve placed nearly as heavy an emphasis on large-cap stocks as the above portfolios (which hold far fewer funds)--thus reducing the target-date fund's appeal as a stand-alone holding. Instead, investors would have to add a small-cap fund to round out their portfolios, and adjust its weighting. It's also worth noting that the target-date fund's 0.81% expense ratio exceeds the four portfolios' weighted price tags by at least 15 basis points each. Granted, adding a small-cap fund to the mix will increase the portfolios' weighted expense ratios a bit, but adding a bond fund would reduce them. One advantage to American's target-date funds, relative to the portfolios, is that investors don't need to adjust their asset allocations as they age. Nevertheless, for those who don't mind making their own adjustments, I believe the four portfolios are more attractive choices, even though investors will likely require a supplemental holding or two.

All told, I remain concerned about asset bloat at American's equity funds, and investors do need to keep an eye on overlap. But I think the above portfolios should serve investors well, and keep them from being significantly impacted by those issues for years to come.

		American Funds Fund Family Report
	Our new eight-page report gives you independent Morningstar opinion and information on these fund families each month.		It includes news, in-depth analysis on what it means for you, the best and worst funds in a family, and much more. Learn more.
	$99.00 for 12 issues