This Gold-Rated Fund May Be Old, but It's Not Outdated

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American Funds American Mutual’s effective balance between capital preservation and growth merits a Morningstar Analyst Rating of Gold. The fund’s approach is old, but not outdated. Since its 1950 inception, the fund has focused on dividend-paying industry leaders while avoiding firms that derive most of their revenue from alcohol or tobacco products. The alcohol and tobacco component of the mandate anticipated by decades the proliferation of socially conscious strategies; and while it limits the fund’s opportunity set, it hasn’t impaired long-term results.

Skilled management, including a best-in-class approach to succession, has been key to success here. Cheryl Frank’s addition to the fund’s now seven-person team shows how American’s multimanager system cultivates talent. She joined the firm as an equity analyst in 2002 and covered healthcare and software stocks, like current top-five holding

The fund’s position in Microsoft helped it outperform nearly three fourths of its peers within the large-value Morningstar Category over the past five years through June 2018. While the fund lagged the S&P 500 over that period, it continued to beat its benchmark in falling markets. During early 2018’s sharp equity market drop, it lost 9% versus 10.1% for the S&P 500.

The portfolio’s resiliency comes from its grounding in above-average dividend payers, yet managers here aren’t forced to stretch for yield. They can buy stocks with relatively low current payouts but more long-term dividend-growth potential. They also make use of their ability to invest up to 5% of the fund's assets in nondividend payers. They bought top-five holding

Process Pillar: Positive | Alec Lucas, Ph.D. 07/30/2018 Since its 1950 inception, this fund has been one of American Funds' more conservative large-cap offerings. Its cautious strategy merits a Positive Process Pillar rating for its ability to grow capital and provide income. The fund's seven managers and two analyst groups, who run their portfolios separately, invest primarily in competitively advantaged and attractively valued dividend payers. (Only 5% of assets may be invested in nondividend payers.) When compelling equity opportunities are lacking, managers can hold cash or bonds, and the fund typically has a 5%-15% combined stake. Regardless of its cash-and-bond exposure, each portfolio must meet an above-market, pre-expense yield target to ensure the fund achieves its income goal. To keep managers from stretching for yield, however, that target is adjusted relative to the S&P 500. Currently, it's about 2.5% versus the benchmark's 1.9% yield.

The fund's eligibility list, which contains around 300 companies, helps the managers find firms that generate steady profit growth. These companies may not derive most of their revenue from alcohol or tobacco products, must have an investment-grade credit rating, and must be an industry leader. Most investments must be domiciled in the United States, but up to 20% of assets may be invested in Canadian companies. A 5% allowance for foreign firms outside of North America provides further latitude.

The portfolio has become more diversified since late 2012, when the fund's asset base was first split between managers from two Capital Group subsidiaries. It now holds roughly 150-170 stocks versus about 120-140 previously. In other ways, the portfolio remains the same. The fund still has a mega-cap focus. Its $90 billion average market cap as of June 2018 was in the large-value category's highest decile. The fund continues to hold good businesses. Its stocks on the whole boast top-quintile returns on assets. Plus, roughly 92% of them carry a competitive Morningstar Research Services Economic Moat Rating (either wide or narrow), which also ranks in the category's top decile. These attributes have contributed to the fund's muted risk scores.

The fund's eligibility requirements can have a big effect on its sector weightings. As the 2007-09 credit crisis deepened, a number of financials firms lost their investment-grade credit rating and dropped off the eligibility list. The fund's financials stake fell from 16% of assets at year-end 2006 to 3% in early 2009. The fund's financials weighting has since increased to 12.3% as of mid-2018, but that was still a bit lighter than the S&P 500's 13.8%. The managers have found attractive opportunities in biotech firms such as top-five holding

The fund's 10.1% cash stake as of June 2018 is typical.

Performance Pillar: Positive | Alec Lucas, Ph.D. 07/30/2018 The fund's dividend-focused strategy and ability to hold sizable cash and bond stakes help it outperform by holding up well in bear markets, earning it a Positive Performance Pillar rating. Since the fund's 1950 inception, it has beaten the S&P 500 in all 14 stock market declines of 15% or more without dividends reinvested. During 2011's sovereign-debt crises, the fund's 14.5% loss from late April through early October beat the index by 4 percentage points and landed near the large-value category's top decile for the period, on its way to a top-quintile category showing for the calendar year.

The fund's defensive posture means that it often lags in market rallies. That can sometimes lead to extended underperformance, as in the 1990s. With profitless tech firms soaring at the end of that decade, the fund's return fell far short of the index's. Over the next decade, however, the fund excelled as the Internet bubble burst, and it weathered the 2007-09 credit crisis better than most. As a result, the fund's 9.5% annualized gain for the 20-year stretch ended on Dec. 31, 2009, was in line with the index's but with about one fourth less volatility.

Strong risk-adjusted performance continues under the current team. From the early 2006 start date of the three longest-tenured managers through June 2018, the fund's 8.1% annualized gain was close to the S&P 500's 8.7%, but with about one fifth less volatility.

People Pillar: Positive | Alec Lucas, Ph.D. 02/28/2018 American Funds' multimanager approach helps to handle this fund's roughly $51 billion asset base. The fund's Positive People Pillar rating reflects its systemic strengths as well as the managers' experience, ability, and aligned interests.

Capital Group, the parent of American Funds, splits these assets between subsidiaries Capital Research Global Investors and Capital International Investors. Joyce Gordon heads up the whole fund and the CRGI team, which is composed of James Lovelace, James Terrile, and Bradley Vogt. William Robbins heads up CII's side, which includes Dylan Yolles and Cheryl Frank, whom the firm publicly named in late 2017. Each manager oversees a separate sleeve of the portfolio, with Gordon and Robbins helping to ensure that their respective teams are balanced across different investing styles. For example, while Gordon's macroeconomic views sometimes affect her stock picks, Yolles prefers to focus on individual firms as he seeks potential turnaround situations. They’re a veteran group. Frank is the least experienced manager on the combined seven-person team and yet she has been in the industry for nearly two decades. The CRGI and CII teams are each supported by about 50 analysts, with each analyst group also responsible for its own slice of the portfolio. Five managers invest more than $1 million each in the fund, one at least $500,000, and one at least $100,000.

Parent Pillar: Positive | 06/07/2018 As a standard-bearer in asset management, Capital Group earns a Positive Parent rating. Widely known in the U.S. for its American Funds open-end lineup, the active manager boasts some of the industry's more reliable equity and allocation offerings. The firm's multimanager system is key to 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 Group has improved its fixed-income approach through greater coordination, external hires, and enhanced risk management. The firm now has the tools to compete with best-in-class fixed-income shops, though its investment professionals could become more seasoned in their use.

Investors have shown renewed interest in American Funds amid the firm's efforts to expand in Europe, Australia, and Asia. The potential for these investors to pour money into the same strategies should incline Capital Group to clarify what would cause it to close a strategy to protect current shareholders, something the firm has said it would be willing to do.

Price Pillar: Positive | Alec Lucas, Ph.D. 07/30/2018 Low fees earn the fund a Positive Price Pillar rating. The A shares' 0.60% expense ratio, which applies to more than half of the fund's assets, has ticked up 2 basis points since fiscal 2015, but it is still 50 basis points below the large-cap front-load peer median. That ranks in the cheapest decile of those peers and is also competitive with the category's better-priced no-load actively managed options. Plus, 12 of the fund's remaining 16 share classes sport Morningstar Fee Levels of Low versus similarly distributed rivals. Brokerage fees of 0.01% of average net assets in fiscal 2017 also fell below the 0.04% category median. Capital gains distributions can hurt investors in taxable accounts, however. In 2017, the fund distributed a capital gain of 4.1% of net asset value in December.