Should American Funds Bring Out More Offerings?

My colleagues and I at Morningstar have often griped about the desire of some large fund shops to offer as many flavors of funds as they possibly can. Such firms tend to launch specialized funds that take advantage of investors' interest in hot corners of the stock and bond markets--which often subsequently cool, causing trend-chasing shareholders to pull out at the wrong time. What's more, these fund rollouts can result in firms investing where they don't have enough expertise, and prospective investors are left to sift through sprawling, confusing fund lineups.

American Funds, on the other hand, has a compact roster of funds, and the firm deserves kudos for its restraint. The firm has had a loyal following among advisors and investors for a long time, but in recent years, its popularity has surged, and it has vaulted Fidelity and Vanguard to become the largest fund family in the United States. It could have easily capitalized on that success by bringing out all manner of funds, but it hasn't. It has instead preferred to have a few broadly diversified, large funds and devote massive amounts of resources to each one. What's more, American typically likes to bring out funds when it sees more investing opportunities in a particular area. Because the firm has felt that most of its bases have been covered, fund rollouts have been rare in recent years. Indeed, the only funds that American has introduced in the past 14 years (or thereabouts) have been  High-Income Municipal Bond  (AMHIX) in 1994,  New World  (NEWFX) in 1999,  Short-Term Bond Fund of America  (ASBAX) in 2006, and its series of target-date funds last year.

That said, I think the firm could stand to augment its lineup. For example, in the November 2007 issue of this newsletter, I discussed four simple portfolios that American Funds investors could put together to cover most of their equity-investing needs, but I noted that the firm offers only one fund that doesn't invest primarily in large-cap stocks ( Smallcap World  (SMCWX)). All the other funds have at least 70% of their equity holdings plowed into large caps. Might investors benefit from more small-cap options? I'll list my five suggestions for new funds from American below, in order of where American might see opportunities.

All-Cap Growth Fund
American currently lacks a fund that sports a true all-cap look, and given the fact that growth stocks have been out of favor for eight years, it seems like an opportune time to launch an all-cap fund with a growth tilt. Perhaps the firm could simply alter the mandate of its smallest equity fund,  New Economy  (ANEFX), to take this spot in the lineup. I haven't been a fan of that large-growth fund's current, quirky mandate to own service and information companies--the definition of which American has expanded over time to an increasing number of sectors and industries, as that portion of the economy has grown. Thus, a tweaking of that mandate might help. And at $9 billion, the fund should still be able to invest across the market-cap spectrum, though it might have a tough time owning small-cap stocks at the top of the portfolio.

Multisector Bond
American has a couple of broad fixed-income funds in  Bond Fund of America (ABNDX) (which owns both investment-grade bonds of all stripes and a single-digit stake in high-yield debt) and  Capital World Bond  (CWBFX), which sports a similar high-yield stake and will own bonds in developed and emerging markets. But I think a truly wide-ranging fund would make a lot of sense, since American has had so much success with other funds that give managers plenty of leeway to invest as they see fit (such as world-allocation fund  Capital Income Builder (CAIBX) and  Fundamental Investors  (ANCFX), a large-blend fund that owns a hefty stake in foreign stocks and will own both deep-value turnaround plays and rapid growers). And the firm clearly has the expertise for a multisector fund: It has long invested in U.S. government bonds, mortgages, corporate debt, foreign developed-market bonds, and emerging-markets bonds.

Small-Cap U.S.-Stock Fund
As I mentioned, American does offer Smallcap World, a massive $24 billion fund that invests in smaller companies all over the globe. However, that fund uses a pretty liberal definition of "small cap"; its managers can buy any company with a market capitalization of up to $3.5 billion. That's roughly double the upper limit of Morningstar's small-cap universe, and the majority of the fund's assets are thus devoted to mid-caps, according to Morningstar. I think a fund dedicated more strictly to small- and even micro-cap stocks would hold a lot of promise, especially given the research advantage the firm's huge investment staff has over most competitors. One significant issue: In order to effectively invest in micro-caps, a fund's size almost has to be limited, and American hasn't shown any inclination to close its funds. So I'm not going to hold my breath waiting for this one to come out. Also, this fund would have to avoid substantial overlap with Smallcap World in order to take significant stakes in its holdings without running into liquidity problems; a focus on companies firmly in the small- and micro-cap range would do the trick. But although I think a fund of this type is a good idea for the long haul, now may not be the best time for it: Small caps have lagged over the past year or so, but they previously enjoyed a seven-year run of outperformance.

Small-Cap Foreign-Stock Fund
Like its domestic counterpart, this fund would have a research edge and would need to stay out of the way of Smallcap World and have its size kept under control. I think the case for both funds can also be made from a structural standpoint: American already has world-stock funds to cover large-cap stocks ( Capital World Growth & Income (CWGIX),  New Perspective (ANWPX)) and small-cap stocks, so why not create similar U.S.-stock and foreign-stock lineups? The firm's globally focused analysts could easily split their ideas between this fund and a small-cap U.S. fund. Also, investors could choose one of the funds to fill out their portfolios if they already own a U.S. or foreign small-cap fund. Again, though, valuations could prove a sticking point at this time.

Global High-Yield
There's a reason I've listed this idea last. Global high-yield funds are rare right now, in part because much of the high-yield market is in the U.S.--and American already has a fine U.S.-focused high-yield offering in  High Income Trust  (AHITX). But given the dramatic growth of many foreign economies in recent years, particularly in emerging markets, more companies outside the U.S. could very well get better access to credit markets in the near future. Also, it's worth noting that American's sister firm that runs funds sold overseas, Capital International, already offers both U.S. and global high-yield funds. Certainly, American has the analytical heft to handle such a fund with aplomb. That said, I have expressed some concern in the past with the large amount of money American plows into the U.S. high-yield market (close to $20 billion total), so I would have to be confident that a new fund would present no serious liquidity challenges. And such a fund might be more appropriate when the non-U.S. high-yield market has grown further. Thus, a global high-yield fund could be launched later rather than sooner.

To be sure, I'm in no hurry to see American significantly expand its fund lineup; these suggestions are forward-looking, rather than glaring holes in the lineup that need to be filled right away. But I believe they are worthy of serious consideration and could help investors better round out their portfolios at American Funds. 

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