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This Big Balanced Fund Is Getting Better

Silver-rated American Funds American Balanced is a giant among allocation funds—and recent improvements on the fixed-income front further boost our confidence.

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The following is our latest Fund Analyst Report for American Funds American Balanced Fund (ABALX). 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.

Rock-bottom fees, strong equity selection, and a recently improved fixed-income effort support American Funds American Balanced's Morningstar Analyst Rating of Silver.

American Funds' most prominent strength is equity research. The equity group supporting this fund is tenured and well-resourced, comprising about 30 portfolio managers and 50 analysts. The firm's stock portfolios have turned in broadly impressive results, and this fund is no exception. Attribution analysis indicates that the fund's equity portfolio has meaningfully surpassed the S&P 500 over the past decade.

The fund's also made well-timed asset-allocation moves. Where the fund falls within its typical 60%-65% equity range depends primarily on the bottom-up decisions of the fund's five equity managers and one balanced manager. When valuations warrant, however, principal investment officer Greg Johnson can use flows to expand or contract the equity portfolio. The team has shown good judgment, growing stocks to 74% of assets by year-end 2013 and then gradually cutting equities to 56% by early 2016 before returning it to its typical range in 2016’s second half. Such shifts have helped the fund readily surpass a 60%-40% weighting of the S&P 500 and the Bloomberg Barclays U.S. Aggregate Bond Index over the past five- and 10-year periods.

Recent improvements on the fixed-income front further boost our confidence in the fund. Process enhancements led us to upgrade several of the firm's bond funds to Bronze in late 2017. The bond portfolio here is designed to serve as ballast to offset equity volatility, a task we think it is certainly capable of achieving.

With $125 billion in assets, this is the largest fund in the allocation--50% to 70% equity Morningstar Category. The fund's multimanager approach helps it handle that asset base, but its size may still limit flexibility. Management has gravitated toward giant caps; its average market cap of $129 billion ranks as the fifth-largest among more than 230 distinct peers. Nonetheless, we expect the fund to fare well thanks to very low fees and capable security selection.

Process Pillar: Positive | Leo Acheson, CFA 04/12/2018 

The fund aims to be a reliable one-stop offering that invests in a mix of stocks and bonds to grow both capital and income. Its prudent approach to achieving that outcome merits a Positive Process rating. The equity managers focus on blue-chip, dividend-paying stocks, like top-10 holding  Philip Morris International (PM), which the fund first bought well before its 2008 spin-off from  Altria (MO). Such stocks predominate, in part because these managers strive for a yield in line with the S&P 500’s, but 10% of assets may be invested in non-dividend-payers. That leaves room for some growth-oriented names, such as current top-10 holding  Amazon.com (AMZN) . The fund’s equity stake may range between 50% and 75% of assets.

The fixed-income portfolio has been a source of risk in the past, but that’s no longer the case. After the fund’s mostly investment-grade corporate holdings and private mortgages hurt it in the 2007-09 credit crisis, management scaled back credit exposure while making Treasuries more prominent in recent years, reducing overall credit risk. The managers now look to fixed income primarily for ballast and to offset equity volatility, with income a secondary consideration. Neither do they take big bets in their duration management. Since mid-2011, they’ve kept the fund’s duration in line with or about a half year shorter than the Aggregate Index’s.

Where the fund falls within its typical 60%-65% equity range depends primarily on the bottom-up decisions of the fund's five equity managers and one balanced manager, who invests in both stocks and bonds. When valuations warrant, however, the principal investment officer can use flows to help expand or contract the equity portfolio, provided it stays between 50% and 75% of assets. In early 2016, for example, concerns about lofty valuations dropped the equity stake to 55.6%.

Even at the upper end of its range, the equity portfolio’s tilt toward mega-cap dividend payers helps keep risk in check. However, the fund can be aggressive in adding exposure to out-of-favor sectors. In 2016, its energy exposure nearly doubled to 7.6% of assets by year-end.

A bond portfolio aimed at capital preservation, rather than yield, further offsets risks in the equity portfolio. After a poor showing during the credit crisis, the fixed-income managers now invest in a relatively tame mix of investment-grade corporates, Treasuries, agency mortgage bonds, and some foreign bonds. The fund does carry interest-rate risk, though. Since mid-2010, its duration has stayed above the category norm. As of March 2017, the fund had a 5.8-year duration versus the typical rival's 4.4 years.

The fund’s 4.2% current cash stake is above its mid-2009 2.1% low but below the double digits that were the norm in the 1990s.

Performance Pillar: Positive | Leo Acheson, CFA 04/12/2018 

Capital Group became this fund’s advisor in 1975. The fund struggled in the 1980s and mid- to late-1990s, frequently falling short of a 60%-40% weighting of the S&P 500 and Aggregate Index. In the early 2000s, however, the fund avoided profitless tech firms and went on a winning streak that has since become the norm, earning it a Positive Performance Pillar rating. From principal investment officer Gregory Johnson’s March 2003 start date through March 2018, the fund’s 8.5% annualized gain beat its blended bogy by 73 basis points, with less volatility, and lands in the allocation--50% to 70% equity category’s top quintile.

While the fund’s performance since early 2003 has been very good, it’s not been flawless. Thanks in part to the fixed-income portfolio’s corporate-bond and private-mortgage holdings, the fund struggled in the 2007-09 bear market. Its 40% peak-to-trough loss trailed its index by nearly 10 percentage points.

Changes since the credit crisis have the fund back on solid ground. The fixed-income portfolio has had less credit risk. Stock selection has been the primary driver of outperformance, though management has also made timely asset-allocation moves. Keeping its equity stake above 70% helped the fund to a top-decile showing in 2013’s rally, while cutting it to 60% led to a top-decile finish in 2015’s more turbulent market.

People Pillar:  Positive | Leo Acheson, CFA 04/12/2018

American Funds’ multimanager system helps to handle this fund's massive $125 billion asset base. The fund's Positive People Pillar rating reflects its systemic strengths as well as the managers’ experience, ability, and aligned interests.

Gregory Johnson, who joined in March 2003, heads up the fund and is one of five equity managers. His equity counterparts include Alan Berro, Jeffrey Lager, Michael Kerr, and Alan Wilson, whom the firm first publicly named in early 2017 when veteran Dina Perry left. Hilda Applbaum also serves as a CWI manager but has a dual role as she invests in both stocks and bonds. The fund has four fixed-income generalist managers: John Smet, James Mulally, John Queen, and Pramod Atluri. Queen replaced the specialist duo of Andrew Barth and Wesley Phoa in July 2016, and Atluri was added to the roster in March 2018 to help the fund deal with its large and growing asset base. Each manager runs a separate sleeve of the portfolio, with Johnson helping to ensure their investing styles complement one another and the fund has the right mix between equity and fixed-income securities. Each manager has at least two decades of industry experience and draws on a deep bench of equity and fixed-income analysts, who run their own slice of the portfolio.

Five managers invest more than $1 million in the fund, and five invest at least $100,000.

Parent Pillar: Positive | 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 | Leo Acheson, CFA 04/12/2018

Low fees earn the fund a Positive Price Pillar rating. The A shares’ current 0.57% expense ratio, which applies to about half of the fund’s assets, is 58 basis points below the moderate-allocation front-load peer group average. That ranked in the cheapest percentile of those peers and was also competitive with the category’s better-priced no-load options. Plus, 11 of the fund’s remaining 16 share classes sported Low Morningstar Fee Levels versus similarly distributed rivals.

At $125 billion in assets, this is the largest fund in its category. It's good to see that management has shared its economies of scale with investors.

Leo Acheson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.