In an Industry of Sprinters, American Funds Demonstrates Its Endurance
The firm is evolving in the face of industry trends--and continued redemptions from its funds--but certain hallmarks remain intact.
Morningstar recently issued a new Stewardship Grade for American Funds. The firm's overall grade--which considers corporate culture, fund board quality, fund manager incentives, fees, and regulatory history--is an A. What follows is Morningstar's analysis of the firm's corporate culture. This text, as well as analytical text on the other four Stewardship Grade criteria, is available to subscribers of Morningstar's software for advisors and institutions: Morningstar Principia®, Morningstar Advisor Workstation(SM), Morningstar Office(SM), and Morningstar Direct(SM).
The deep roots of American Funds' more than 80 years of investing success are many and intertwined, though for the most part, they can be traced to a few sources: the firm's trademark multimanager system; a stable and long-tenured team of investment professionals; and an incentive system that allows those professionals to take the long-term view in an increasingly myopic market. Combined, American and its parent company, Capital Group, have leveraged those characteristics to impressive results, particularly on the equity side of their business, where the vast majority of American's assets under management reside.
American Funds' cultural strengths begin at the founding of its parent company, Capital Group, in 1931 by investor Jonathan Lovelace. Since then, investors have remained firmly at the helm of this privately held company, and longtime portfolio managers such as Tim Armour, Rob Lovelace, and Jim Rothenberg comprise the majority of the firm's management committee. That group sets the firm's overall business direction, and its guidance mirrors the patient and long-term nature that have long been the hallmarks of the firm's investment offerings.
Where Autonomy and Patience Prevail
The firm pioneered the use of multimanager investing in the 1950s, and the system has since become inextricably tied to the firm's identity. The current structure allows sometimes a dozen or more managers, and usually analysts as well, to independently manage slices of a fund's portfolio. This generally results in well-diversified funds that are less volatile than their respective peers, helping investors to stay in them through all sorts of market environments (though financial advisors, the company's predominant sales channel, also play an important role here).
The multimanager system also has its advantages when transitioning portfolio managers (called portfolio counselors by the firm) on and off funds. Easing managers onto small slices of funds means that investors won't experience the jarring change in investment process that sometimes occurs with single manager funds. In addition, managers have usually already clocked in with multiple years of live performance history as analysts before they're named to a fund's official roster; that gives the firm's senior leaders plenty of time to observe each manager's investment style, helping those leaders to assemble groups of complementary managers.
At the same time, disclosure surrounding the multimanager system reflects American's insular, private nature, but is also deficient in an industry that's among the most-transparent in the financial-services realm. Although American satisfies the letter of current regulation, the firm acknowledges that there are some portfolio managers, generally running less than 5% of a fund's assets, that aren't disclosed in fund documents. American says this gives an analyst something of a trial period, both to test his skills and to allow an analyst to test the portfolio-management waters; but even with a small percentage of assets, these undisclosed managers could be responsible for billions of dollars. Even for the named managers, American doesn't share what percentages of fund assets each portfolio manager is running, so it can be tough for fundholders to tell who has more or less influence on fund performance. American isn't the only fund company to exercise these options, but this kind of omission is unusual.
As for transitioning managers off funds, more often than not, those moves involve retirements or movements of portfolio managers between funds--not investment personnel leaving the firm. In fact, American Funds investors enjoy some of the most stable and long-tenured investment teams around. That level of experience includes not only portfolio managers, but it also extends to the firm's analyst roster. In contrast to other firms where being an analyst often represents a mere steppingstone to a coveted portfolio manager position, Capital's career analyst path ensures that the firm's analysts can be just as well rewarded as a diversified portfolio manager. In many cases, portfolio managers also continue to have analyst duties.
At Capital, it's not unusual for portfolio managers and analysts alike to spend their entire investment careers at the firm, starting as entry level undergraduate- or graduate-level hires and finishing at retirement several decades later. Achieving that level of stability starts at the hiring process, where it's not unusual for candidates to go through several dozen interviews as the firm tries to assess a candidate's fit for Capital's collaborative and intellectually charged environment.
That level of exclusivity, along with an unfailing orientation toward longer-term investing, has worked well for its equity offerings; seven out of American's 12 equity funds place in their respective group's top quartile over the last decade through June, and three more place in the top half. The firm's incentive plan emphasizes four-and eight-year returns, and in a market increasingly sensitive to short-term fluctuations, the firm's longer-term incentive structure allows managers to avoid a myopic view of the market. That level of patience has fueled the firm's equity fund performance and is entwined with the firm's low personnel turnover and level-headed culture.
The Fixed-Income Conundrum
The firm's defining features haven't translated as readily to success in its fixed-income offerings. As bond markets have evolved over the last decade to become more interconnected and reliant on macro considerations, the firm's multimanager format and traditional focus on bottom-up, fundamental credit research have struggled to keep up. Some of the issues stem from the firm's insular qualities; though low personnel turnover has benefited investors overall, they have also appeared to somewhat cloister the bond team from a rapidly changing fixed-income market.
To Capital's credit, the firm has started to acknowledge and address some of its issues. For example, it's become more apparent that the relatively unfettered independence enjoyed by managers on the firm's equity funds may not work as well on the fixed-income side, where more macro level moves (such as duration or sector positioning) greatly influence performance. In trying to address the tension between implementing tighter controls and preserving manager independence, the firm has been using a few new tactics, including making managers more aware of one another's portfolios and using analyst and sector portfolios as signaling tools for how diversified managers should consider positioning their investments.
It's also taken the uncharacteristic step of hiring for a few senior level positions from outside the firm in recent months. The high quality of those hires brings with it the possibility that, though the firm's fixed-income efforts may be a few years behind competitors, it may not take as long to catch up with them. Lessons imparted so far by those new hires include the need to monitor bond sectors where the firm has no investments (such as credit derivatives), as well as to pay attention to how short-term shocks affect the market, even if managers continue to stick to longer-term views.
Catalysts For Change
Meanwhile, five consecutive years of asset outflows plus a secular decline of pension plan assets have prompted a newfound desire to be more responsive to investor and advisor needs, bringing about a few more changes. In a little over a year, for example, the firm has largely acquiesced to advisor demand by launching eight static allocation fund of funds, seven college target-date fund of funds, and three bond sector funds. Despite the prolific number of new funds from a firm that has historically created new funds based on internally determined research opportunities and done so only sporadically, it's reassuring to see that none of these new offerings are particularly trendy in nature. Indeed, the firm has also exercised caution in launching its newest bond funds. American seeded the three sector funds--composed of global high yield, inflation-linked, and corporate offerings--in December 2012 and still has not opened them to outside investors. The firm has also stepped up its marketing efforts, though here, too, the effort has been measured, focusing on educating advisors rather than pushing products.
The more far-reaching change prompted by the firm's net outflows involves the recent reorganization of its equity team, though even then, there's minimal reason for concern. The diminished role of domestic pension plans has taken its toll on Capital's institutional asset management business, so about a year ago, the firm began the process of taking away the distinctions between retail (mutual fund) and institutional (separate account) investing efforts. Portfolio managers are now just as likely to manage mutual funds as they are separate account assignments, and for mutual fund investors, it means the addition of a new equity team to the mix, though one that's not an entirely unknown entity. After all, the previously solely institutional group operates under the same incentive system and enjoys the same resources as the retail group.
There's no doubt that American has seen its share of changes over the past year and a half. And while the firm's fixed-income evolution remains an open question, there's reason for optimism. Overall, though, the firm remains a shining example of a strong investment culture.
This article is the Corporate Culture portion of the Morningstar Stewardship Grade for Funds for American Funds. Click here to see Morningstar's Stewardship Grade methodology.