Denning News Shouldn't Detract From American Funds

A BBC News story posted online on Oct. 21, 2019, has dispelled much, though not all, of the mystery surrounding Mark Denning's departure from Capital Group. The veteran American Funds investor had left parent company Capital Group about six weeks prior on Sept. 9 for what the firm would only describe at the time as a "personnel decision." As it turns out, conflicts of interest were at the heart of the matter.

The BBC discovered that Denning, while a portfolio manager on American Funds SMALLCAP World SMCWX, had invested that strategy’s money for years into Hummingbird Resources, even as his adult daughter became engaged and married to Hummingbird Resources’ CEO Daniel Betts. The portion of SMALLCAP World’s assets invested in Hummingbird Resource was relatively tiny; it peaked at less than 4 basis points in September 2017. It did, however, represent a significant stake in the company, more than 7% of shares outstanding as early as January 27, 2011, per regulatory filings.

The BBC also discovered the existence since Aug. 31, 2017, of a private third-party family trust called IPF Investment Fund - Global Opportunities” (formerly Morebath Fund - Global Opportunities), which it alleges is connected to Denning, at least indirectly. The trust holds or has held several stocks in common with two of Denning’s American Funds strategies, SMALLCAP World and American Funds New Economy ANEFX. One of those stocks is Hummingbird Resources, for example. Like the Hummingbird Resources position in SMALLCAP World, these other stocks, seven in total and not just the three mentioned by the BBC, represented relatively tiny stakes within their respective American Funds’ portfolios, even if those funds’ ownership of the companies’ shares outstanding was significant.

Capital Group was not aware of any of this until the BBC contacted the firm for comment during the week of Sept. 2-6. Once informed, Capital Group acted swiftly. Despite Denning’s more than 35-year tenure and his reputation as one of the firm’s savviest investors, he was gone within a matter of days.

Since this news first broke, Morningstar Manager Research analysts have spent many hours assessing as far as possible what happened. That’s included conversations with senior Capital Group personnel, such as Chairman Timothy Armour, detailed analysis of the ownership of the stocks in question within SMALLCAP World and New Economy, and considerable internal dialogue.

Morningstar has concluded that Capital Group’s Code of Ethics should be strengthened. In its current form, the Code only requires disclosure of investments involving family members living in one’s household and does not directly address investments like Hummingbird Resources, which involved a family member not living in one’s household at the time. The Code of Ethics does, however, forbid investment personnel from involvement in family trusts that hold the same securities as their American Funds’ strategies. Despite the existence of such a trust, it does not appear that Denning’s actions harmed fundholders, and it’s unclear there was something reasonable Capital Group could have done to flag the ethically questionable behavior that went unreported in this case until the BBC revealed it. Based on what Morningstar has seen thus far, this very unfortunate situation should not detract from Capital Group’s stature as an industry standard bearer in many respects, a position it has secured by serving investors well for nearly 90 years. Capital Group retains its Positive Parent rating.

Morningstar will have more to say on the details surrounding Denning’s departure and the lessons to be learned from it, as they touch on many issues. In the end, though, investors in Capital Group’s American Funds should rest assured that their assets are still in good hands.