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Seeking Dividend-Paying Industry Leaders? Stop Here

Gold-rated American Funds Washington Mutual has built a remarkable record by buying dividend payers with good growth prospects on the cheap.

The following is our latest Fund Analyst Report for American Funds Washington Mutual AWSHX. Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

American Funds Washington Mutual receives a Morningstar Analyst Rating of Gold for its disciplined pursuit of companies with sound growth prospects and a history of paying dividends.

The fund's strict investment criteria keep its portfolio centered on dividend-paying industry leaders, but the key to its success has been management's knack for buying these stocks when they go on sale. For example, the managers built most of the fund's position in current top holding

Thanks to Microsoft and top-20 positions in

Management's reticence to overpay for stocks has contributed to the portfolio's resiliency. Since longest-tenured manager Alan Berro started here in 1997, the fund has lost less than the S&P 500 in two bear markets and several corrections, most recently early-2018’s sharp drop. And thanks to outperformance in these down markets, the fund has a slight edge over the S&P 500 on Berro’s watch.

True, except for Berro and Jeffrey Lager, who started in 2004, none of the five other managers can lay claim to the fund’s record prior to 2013. But the current team is hardly unproven. Mark Casey, whom the firm publicly named in July 2018, is the least-experienced manager and yet he has already been in the industry for nearly two decades and has managed Gold-rated sibling

Process Pillar: Positive | Alec Lucas, Ph.D. 09/18/2018 This fund's inclusion requirements are the strictest among American Funds' large-cap offerings, but they've proven their worth and merit a Positive Process Pillar rating. Founded in 1952, the fund's investing criteria are rooted in rules formed in the Great Depression's aftermath to ensure prudent management of trust funds. Potential investments must clear a number of hurdles, including largely shunning the sale of alcohol and tobacco products. Firms must meet New York Stock Exchange listing requirements, even if they are not listed on the exchange. S&P 500 constituents, however, must make up 90% of the portfolio, which naturally leads to extensive overlap with the index. In 2010, American raised the limit on foreign holdings to 10% of assets from 5%, but the fund still remains one of its purest plays on U.S. large-cap stocks.

The fund's focus on income is similarly old-school, as it pursues yield in a disciplined way. It aims for a dividend yield greater than that of the S&P 500, but the fund largely sticks to investment-grade companies with a long history of paying dividends. In fact, only 5% of the portfolio may be invested in non-dividend-paying companies. Plus, firms must have paid their dividends in eight of the past 10 years and earned them in four of the past five years, which generally disqualifies those that have borrowed to cover their dividend in lieu of an earnings shortfall.

The fund’s 130- to 150-stock portfolio stays rooted in profitable mega-caps. Over the past decade through June 2018, its stocks have consistently had a higher return on equity on average than the S&P 500. It also tends to have a higher weighting in companies with long-term competitive advantages. The current portfolio has 50.6% of its assets in stocks with a wide Morningstar Economic Moat Rating, versus 46.8% for the S&P 500.

The fund’s dividend requirements can have a big effect on its sector weightings. Even as bellwethers, like top holding Microsoft, have long since paid a dividend, the fund has stayed light in tech relative to the S&P 500. As of June 2018, the fund’s 17.6% tech stake was 8.4 percentage points less than the index. Widespread dividend cuts within a sector, whether energy in 2016 or financials during the 2007-09 credit crisis, can also lead companies to drop off the fund’s eligibility list for years. As the 2007-08 credit crisis deepened, for example, the fund’s financials stake fell to a low of 7.5% of assets in mid-2009, as roughly 20 other financials firms cut or eliminated their dividends. Only in late 2017 did the fund return to a modest overweighting in financials.

The fund’s investing criteria also keep it from owning alcohol or tobacco companies. It can, however, hold defense stocks, like

Performance Pillar: Positive | Alec Lucas, Ph.D. 09/18/2018 The fund receives a Positive Performance rating for its strong record. From longest-tenured manager Alan Berro's July 1997 start date through August 2018, the fund's 8.1% annualized gain beat the S&P 500 by 0.3 percentage points and placed in the top quartile of the roughly 260 large-value and large-blend funds that have been around that long (the portfolio has been in both sections of the Morningstar Style Box). The fund's risk-adjusted results are even better.

The portfolio’s grounding in mega-cap dividend payers has a big impact on the fund’s short-term relative performance. When more-speculative fare leads the way, the fund tends to lag. That was the case in the late 1990s, 2009, and 2012. The fund’s 12.5% gain in 2012, for example, trailed the index by 3.5 percentage points and finished in the bottom quartile of the fund’s category.

In turbulent conditions, however, the fund tends to hold up better than most. It outperformed in the early 2000s bear market and the 2007-09 credit crisis, as well as in years in which the market experienced a sharp drop. In 2011, treading lightly in financials helped the fund to a 7% gain, which beat the index by nearly 5 percentage points. Even with an overweighting in hard-hit energy stocks, the fund again held up well in the 2015-16 correction. Its 10.7% peak-to-trough loss was 2.2 percentage points less than the S&P 500's.

People Pillar: Positive | Alec Lucas, Ph.D. 09/18/2018 American Funds' multimanager approach helps to handle this fund's nearly $110 billion asset base, one of the biggest actively managed large-cap domestic-equity funds. The fund's Positive People rating reflects its systemic strengths and the managers' experience, ability, and aligned interests.

Capital Group, the parent of American Funds, has split these assets between subsidiaries Capital World Investors and Capital International Investors since early 2014. Longest-tenured manager Alan Berro, who started here in 1997, heads up the whole fund and CWI’s team, composed of Alan Wilson, Brady Enright, and Jin Lee. Eric Stern heads up CII’s side, which includes Jeffrey Lager and Mark Casey. Lager and Casey had managed money here as members of CWI and Lee as part of CII prior to July 2018, but they switched subsidiaries amid a firmwide reorganization of investment personnel. The managers, based in Los Angeles and San Francisco, each oversee a separate sleeve of the portfolio, with Berro and Stern helping to ensure their investing styles complement one another. Casey is the least experienced manager and yet has nearly 20 years of industry experience. The CWI and CII teams are each supported by about 50 analysts, with each analyst group also responsible for its own slice of the portfolio.

Three managers invest at least $500,000 each here, and four more than $1 million each.

Parent Pillar: Positive | Alec Lucas, Ph.D. 02/28/2018 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. 09/18/2018 Low fees earn the fund a Positive Price Pillar rating. The A shares' 0.57% expense ratio, which applies to more than half of the fund's assets, is 52 basis points below the large-cap, front-load peer median. That easily ranks in the cheapest decile of those peers and is also competitive with the category's better-priced no-load 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 2018 also fell below the 0.04% trailing one-year peer median.

Capital gains distributions can hurt investors in taxable accounts, however. The fund distributed a capital gain of 3.27% of net asset value in June 2018 and before that 3.25% in December 2017.

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