Don’t Settle for Average | American Funds

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Don’t Settle for Average

Our equity-focused American Funds have a track record of outpacing the market.

Key Takeaways

  • In aggregate, U.S. equity managers have failed to consistently outpace the Standard & Poor’s 500 Composite Index.
  • Cutting-edge research shows investments with two identifiable investment traits — low expenses and high manager ownership of funds — have tended to outpace the market index more frequently than peers.
  • Adding investments from investment managers with proven track records of outpacing the market can improve clients’ investment outcomes.
     

Research Reveals Distortions of the Averages

Academic research tends to dwell on the fact that the average investment manager fails to outpace the market over meaningful time periods. It’s true. But this analysis often overlooks demonstrable evidence that while most investment managers lag their benchmarks, many have led. Specifically, U.S. equity managers have delivered index-beating results 42% of the time in the 20 calendar years ended December 31, 2016.

The question is why some investment managers are better than average and how to find them ahead of time.
 

“The Average Investment Manager Can’t Beat the Index” True, but Not the Whole Story

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Source: Data from Morningstar.1

A Deeper Dive Into American Fund’s Track Record of Superior Returns

Over various market cycles and time frames, American Funds equity-focused funds have added value. Overall results demonstrate that our investment strategies have outpaced their indexes the majority of the time, and actually did better over longer periods.

Results for 18 equity-focused American Funds over every possible one-, three-, five-, 10-, 20- and 30-year rolling period (monthly basis) between 1934 and 2016 were analyzed. The funds’ overall active success rate — or the percent of rolling periods in which we outpaced the index — was superior for each investment horizon considered, from one year to 30 years. The record stands as a testament to Capital Group’s system and process of investment management.

Our Equity-Focused American Funds Have a Long History of Outpacing the Market

IS06 Chart2

Source: Data from Morningstar. Data from published sources were calculated internally.2

Are Returns Reliable? Repeatable?

Some critics contend it’s challenging to find managers that can continue to provide above-benchmark returns based on past results. Persistency has been relatively abundant for American Funds equity funds. More often than not, our funds have led their indexes and continued to lead in the subsequent period.

We believe persistency is a criterion that can help investors select funds with the potential to add value in the future.
 

Funds Have Led Their Indexes and Often Continued to Lead in the Subsequent Period

IS06 Chart3

Source: Data from published sources were calculated internally.3

Fund That Share Two Traits Have, on Average, Added Value

While data show that some mutual funds can create value, the next question is how to identify these funds ahead of time. Cutting edge research can help advisors identify quantifiable traits of investment managers that have tended to add value to portfolios over time. Two traits in combination can be helpful in identifying funds with a track record of outpacing indexes over long periods — low expense ratios and high manager ownership.4

Specifically, the research of U.S. and foreign large-cap categories shows:

  • Funds with lower expense ratios have tended to outpace their peers over time.
  • Investment firms whose managers invest more of their own money in their funds have tended to outpace their peers over time.

Look for Two Manager Traits in Core Portfolios … Although many metrics were relevant, expense ratio and manager ownership stood out in our study.

IS06 Chart4

Source: Data from published sources were calculated internally.4

We examined the funds in Morningstar’s U.S. and foreign large-cap categories over a 20-year period and ranked them into quartiles based on their level of expense ratios or firm-level manager ownership. We found the group of funds belonging to both quartiles — those that had the highest manager ownership and lowest expense ratios — meaningfully improved average outcomes for investors over the periods we analyzed.

Additionally, low expense ratios and high manager ownership significantly improved success rates versus the index, and were associated with greater average risk-adjusted returns. The portfolio of large-cap funds with those two traits outpaced indexes more frequently than other funds in the periods we analyzed. The portfolio also generated meaningfully greater alpha (a measure of risk-adjusted results).

Together, these screens significantly boosted success rates over the periods we studied. Because large-cap equity occupies such a large part of most portfolios, higher success rates can result in substantial gains.
 

Two Steps Raised the Success Rate Success Rates in Large-Cap Equities (Net of Fees)

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Source: Capital Group, based on Morningatar data.4

Evidence Shows Why Success is Not Average

Despite our research showing that funds with low expenses and high manager ownership tend to generate above-average results, it’s rare for investment managers to meet both screens. Our universe reveals that just 96 U.S. large-cap equity funds, or 4% of the relevant fund universe met both of those criteria. It’s a similar rarity among large-cap international equity funds.
 

Look for Funds That Meet Two Key Criteria Large-Cap Equity Funds With Low Expense Ratios and High Manager Ownership

IS06 Chart6

Source: Capital Group, based on Morningatar data.5

How Capital Delivers on These Two Factors

The rarity of investment management firms that meet these criteria may explain why some of the American Funds have been able to deliver solid results. Each of the nine American Funds in the Morningstar universe we studied were in the top quartiles of expense ratios and manager ownership. Looking at the metrics in our study, a 50/50 U.S. and international equity portfolio made up of these nine American Funds would have delivered outcomes that were superior to the index portfolio.Over the five-year periods we studied, this American Funds portfolio would have generated, on average6:

  • 169 basis points more return
  • 201 basis points more alpha
  • 1025 basis points less in downside capture
  • 108 basis points less in standard deviation

1Data from Morningstar. Based on calendar-year returns of actively managed funds, excluding the American Funds, whose relevant benchmark is the S&P 500 Index. This universe excludes funds that fell in the Morningstar Moderate and World Allocation categories. Funds with incomplete data were removed from the analysis. For more information about filtering methodology, see Methodology.

2Data from published sources were calculated internally. Numbers of periods are based on rolling monthly data for all funds — reducing entry- and exit-point bias and better reflecting the range of entry points experienced by investors. American Funds represents 18 equity-focused funds, in aggregate: AMCAP Fund, American Balanced Fund, American Funds Global Balanced Fund, American Mutual Fund, Capital Income Builder, Capital World Growth and Income Fund, EuroPacific Growth Fund, Fundamental Investors, The Growth Fund of America, The Income Fund of America, International Growth and Income Fund, The Investment Company of America, The New Economy Fund, New Perspective Fund, New World Fund, SMALLCAP World Fund, American Funds Developing World Growth and Income Fund and Washington Mutual Investors Fund. For each fund’s comparable index/index blend, see Methodology. Past results are not predictive of results in future periods.

3Data from published sources were calculated internally. Numbers of periods are based on rolling monthly data for all funds — reducing entry- and exit-point bias and better reflecting the range of entry points experienced by investors. American Funds represents 18 equity-focused funds, in aggregate. For the list of funds and their comparable indexes/index blends, see Methodology. Past results are not predictive of results in future periods.

4Source: Capital Group, based on Morningstar data. Based on monthly returns from January 1997 to December 2016. U.S. funds are those in the Morningstar Large Value, Large Blend and Large Growth categories. U.S. index is S&P 500. International funds are those in the Morningstar Foreign Large Value, Foreign Large Blend and Foreign Large Growth categories. International index is MSCI ACWI ex USA. The indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index. Unless otherwise indicated, all distributions were reinvested.

5Source: Capital Group, based on Morningstar data. Domestic funds are those in the Morningstar Large Value, Large Blend and Large Growth categories. International funds are those in the Morningstar Foreign Large Value, Foreign Large Blend and Foreign Large Growth categories. Size of quartiles varies because those funds in the Morningstar database that did not include an expense ratio or firm-level investment ownership were excluded from the analysis.

6Source: Capital Group, based on Morningstar data. Based on monthly returns from January 1997 to December 2017. U.S. funds are those in the Morningstar Large Value, Large Blend and Large Growth categories. U.S. index is S&P 500. International funds are those in the Morningstar Foreign Large Value, Foreign Large Blend and Foreign Large Growth categories. International index is MSCI ACWI ex USA. The indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index. Unless otherwise indicated, all distributions were reinvested.


Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing. 

Content contained herein is not intended to serve as impartial investment or fiduciary advice. The content has been developed by Capital Group, which receives fees for managing, distributing and/or servicing its investments.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice. 

Past results are not predictive of results in future periods.