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American Funds' 2018 Winners and Losers

Alec Lucas, Ph.D.
Christine Benz

Christine Benz: Hi, I'm Christine Benz from Morningstar.com. How does a firm-wide reorganization at Capital Group affect various funds under the American Funds umbrella? Joining me to discuss that topic is Alec Lucas, he's a senior analyst in Morningstar's manager research group.

Alec, thank you so much for being here.

Alec Lucas: Thanks for having me.

Benz: Let's discuss this reorganization, I remember that the Capital had one, say, five years ago, this is another big one. Let's talk about what they did and specifically what the implications are for fundholders.

Lucas: It started in late 2017, it wrapped up in April of this year, and then they implemented the changes in July. More or less roughly every five to seven years or so depending on what's happening with the firm, what's happening with the market, Capital Group will step back and appoint committees essentially to look at everything that they are doing and re-evaluate it anew. The basic question they ask the managers to respond to is what's getting in your way of fulfilling your investment responsibilities. 

The firm's real goal is to have superior investment results over a full market cycle. They are asking their managers what's preventing you, you think, from delivering superior investment results over a full market cycle. They asked that question at the end of last year and they have come back. The last time they did this was in 2011-12 time frame and that’s when they did away with their institutional business Capital Guardian Trust. They essentially reformed it into retail, and institutional they did away with that division. And now they have three equity subsidiaries, Capital International Investors, Capital World Investors, Capital Research Global Investors and then a fixed-income division, Capital Fixed Income Investors.

That's significant here because what happened in this most recent reorganization, is they moved around investment personnel, roughly 30 investment personnel have changed subsidiaries. More than half of that were portfolio managers and to a lesser extent analyst moves. The big deal about changing investment subsidiaries if you are changing between the equity subsidiaries is that there is a 90-day embargo on talking through investment ideas. Capital Group really talks a divide-and-conquer approach to how they manage assets. They'll split an asset base into separate sleeves of individually managed strategies, inline with the managers conviction and style. One of the ways they have done this is they realized, they could split up into separate equity subsidiary, sometimes all sharing a fund between the subsidiaries. You have more diversification because the managers are not necessarily sharing ideas across the subsidiaries. They are sharing them within the subsidiaries, but not across the subsidiaries.

One of the things they did in this most recent reorg is they took American Funds Small Cap World, which is a very large small- and mid-cap global fund ,and they added an equity subsidiary to it. Prior to July of this year Capital International Investors, their third equity subsidiary had not managed a portion of that fund, and it is doing that going forward.

Benz: For managers who are affected by changes like these, what would be the biggest challenges for them going from one subsidiary to a new subsidiary?

Lucas: The biggest challenge is they have to get used to a whole new set of portfolio manager colleagues and also analysts. At Capital Group all the portfolio mangers put in roughly decade or so as an analyst themselves. They are very experienced in analyzing companies, but a lot of the work of on the ground research, the analysts do that and so when you switch subsidiaries, you don't have access to your prior group of analysts that helped you build your portfolio and were a source of dialog, and you have to get used to a new group of analysts. One of the managers I talked to says he thinks it will be challenge for a candidate, it will take a few years to really be as familiar with the new analyst group as he was with the prior one. But at the same time, they think that the long-term benefits of shaking things up, trying to get managers not become complacent in the way they think, or the way do things really has helped them maintain excellent results over full market cycles.

Benz: I know that one of the ideas behind having this multimanager setup across all of the funds is that its designed to kind of ease transitions whatever they might be.

Lucas: One of the strengths of the system is that there is a very little key-person risk in the managing of assets. You can take a manager off of his strategy and put him or her on a different strategy, and that’s helpful. A lot of times when these managers move between subsidiaries in many cases, they are staying, managing the same pool of assets. A lot of the movements were between subsidiaries that already managed the same fund.

Benz: Let's talk about fund flows into the firm's lineup. It's been a difficult year for both equity and bond investors. How has the firm been faring in terms of seeing new asset inflows?

Lucas: Capital Group really did very well in the early 2000s bear market and saw lot of inflows and did actually quite well overall in the financial crisis, but not nearly as well as they had done in the early 2000 bear market …

Benz: In terms of performance.

Lucas: Yeah. They have seen inflows. There has been the secular shift to passive that they've experienced, but as an active manager they've really stood out in terms of doing well. The data that we have right now is through October of this year, and they've taken in about $22 billion. That ranks fifth; Vanguard's first with nearly $140 billion. They are quite a bit behind that, but American Funds continues, at least in the U.S. retail mutual fund world, they continue to be a distant second to Vanguard in terms of their market share at about 8.43%, and Fidelity is close behind at 8.37%. But of course, Fidelity has active as well as passive strategies.

Benz: These would be mutual fund assets, so excluding the ETFs.

Lucas: The figures I looked at actually included ETFs, because Capital Group has made a decision not launch ETFs. They filed for transparent actively managed ETFs but haven’t done that. The figures I looked at included ETFs in the asset managers just because they think that in today's world, firms are choosing to do both, index funds, open end funds, and ETFs.

Benz: Let's take a look at the performance across the firm's lineup. You pulled out a few funds that have performed exceptionally well in this tricky market environment. American Funds American Mutual is one of the better performing funds relative to its category peers. What's been working for it.

Lucas: It's a defensive fund. They have a high-yield target that the managers must meet, and this is the kind of market environment where you'd expect this fund to do well. The S&P 500 had a sharp correction early in the year and had a near correction just most recently and may avoid a full correction here at the end of the year, but it's been a pretty volatile year. A defensive fund like American Funds American Mutual is what you'd expect to do well. They have a position in Microsoft that’s done very well for them, and it's the kind of fund that’s showing up when it should.

Benz: New World is another fund that has performed well relative to its category peers, not so great in the absolute terms. Let's talk about that fund, it's complexion, and why it would tend to do well relative to pure emerging-markets equity funds in a market like this.

Lucas: Through November with a month to go it was down 9% which of course loosing 9% is not good, but that was close to top decile results in the diversified emerging-markets category. It's a unique fund and in some ways it's a great fit for the diversified emerging-markets category and in some way its an odd fit. So, what it aims to do is to tap the growth in emerging markets and it does this by investing in companies that are domiciled in emerging markets, but also companies domiciled in developed markets including the United States that get at least 20% of their revenues or 20% of their assets in emerging economies. They have a relatively low threshold of 20% because they want to get the growth that might come from growing those revenues from 20% to 50%. If they made a higher threshold, they might not necessarily experience that growth. It's the kind of fund that when emerging markets really get hit hard you expect this fund to do well relative to its peers. It's done well relative to its peers, it tends to lag when emerging markets deliver strong returns, and that was true as well previously.

Benz: Let's talk about some funds that have not performed as well one is American Funds Fundamental Investors--not ranking well relative to its category peers at least for the year to date through the end of November.

Lucas: American Funds Fundamental Investor is very flexible fund, and it's always had a pretty broad ability to invest in non-U.S. stocks. I think that’s figured into the results here. But again, it's not done horribly this year. It's up about 88 basis points, and so that's more than the S&P 500, but relative to its category it's not doing as well. But not so bad in absolute terms. So again contrast that with New World which has lost 9%. 

The fund that's struggled relative to its category most is New Economy. It had done very well in 2017 and is up 2.5% through November of this year, but that’s bottom decile in its U.S. large-growth category. Large-growth stocks have done the best, and New Economy, similar to Fundamental Investors' story, here is you have a broad mandate, the ability to invest in companies domiciled overseas and so a significant weighting in emerging markets in Chinese stocks like Tencent and Alibaba. That’s been headwind for that fund.

Benz: Alec great overview, lot of people paying attention to what's going on at Capital Group. Thank you so much for being here to provide the recap.

Lucas: Thank you.