Can American Funds Sustain Its
Outperformance?
June 30, 2015
by Larry Swedroe
Among actively managed funds, American Funds has a reputation for providing investor-friendly, lowcost products with sustained records of outperformance. But has it outperformed comparable funds
from Vanguard and Dimensional Fund Advisors (DFA)? If so, should investors expect its funds to
maintain their edge?
I’ll answer those questions.
American Funds is the third largest mutual fund family (following Vanguard and Fidelity) in the United
States. According to Morningstar, as of May 31, 2015, American Funds had nearly $1.3 trillion in
assets under management across its lineup of mutual fund offerings.
The firm is an extremely popular choice among active investors and for some very good reasons. The
fees it charges are investor friendly, certainly so for an active manager. American Funds doesn’t rely
on “star managers” who can pick up and leave, taking their investment approach with them. Rather,
the firm relies on a team of managers. It avoids the style drift that causes investors to lose control over
the risk of their portfolios. And finally, the firm has become one of the market’s largest mutual fund
companies because its track record is good.
The firm’s website states: “We base our decisions on a long-term perspective, which we believe aligns
our goals with the interest of our clients. Our portfolio managers average 27 years of investment
experience, including 22 years at our company, reflecting a career commitment to our long-term
approach.”
American Funds describes its investment philosophy as “based on doing what…is right for clients.” It
claims to “reward long-term results” through investment professional compensation that’s “heavily
influenced by results over four- and eight-year periods” and to “invest alongside” its clients. Collectively,
the firm notes, its “associates are significant investors in the company’s investment offerings.”
Recognizing the long-term success achieved by the Capital Group (the firm that manages the
American Funds family of mutual funds), Charles Ellis wrote about them in his 2004 book, Capital:
The Story of Long-Term Investment Excellence.
Active versus passive
As is my practice, and given the firm’s assertions about its long-term investment approach, I’ll compare
the performance of American Funds’ actively managed equity funds to similar offerings from two
Page 1, ©2016 Advisor Perspectives, Inc. All rights reserved.
prominent providers of passively managed funds, DFA and Vanguard. (Full disclosure: My firm,
Buckingham, recommends DFA funds in constructing client portfolios.)
To keep the list to a manageable number of funds and to make sure I look at long-term results through
full economic cycles, I will analyze the 15-year period that ended June 12, 2015. Also, I’ll use the
lowest cost shares available when more than one class of fund is available for the full period.
Furthermore, in cases where American Funds has more than one fund in an asset class, I’ll use the
average return of those funds in my comparison.
The table below shows the performance of seven funds offered by American Funds in five asset
classes.
15 Years Ending June 12, 2015
Page 2, ©2016 Advisor Perspectives, Inc. All rights reserved.
Symbol
Annualized
Return (%)
Expense
Ratio (%)
Fundamental Investors
RFNFX
6.8
0.35
Investment Company of America
RICFX
6.1
0.35
6.5
0.35
Fund
U.S. Large Blend
American Funds Average
DFA U.S. Large Company
DFUSX
4.5
0.08
Vanguard Institutional Index
VINIX
4.5
0.04
AMCAP
RAFFX
6.9
0.41
Growth Fund of America
RGAFX
5.7
0.38
New Economy
RNGFX
5.3
0.52
6.0
0.44
VIGIX
3.7
0.08
American Mutual
RMFFX
7.6
0.36
Washington Mutual
RWMFX
6.8
0.35
7.2
0.36
U.S. Large Growth
American Funds Average
Vanguard Growth Index
U.S. Large Value
American Funds Average
DFA U.S. Large Cap Value
DFUVX
8.9
0.13
Vanguard Value Index
VIVIX
5.8
0.08
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Foreign Large Growth
Europacific Growth
RERFX
5.3
0.54
Vanguard International Growth Admiral
VWILX
4.4
0.34
New World
RNWFX
8.1
0.69
DFA Emerging Markets
DFEMX
8.2
0.56
Vanguard Emerging Markets
VEIEX
8.1
0.33
Emerging Markets
Before reviewing our results, it’s important to note that the lower-cost R5 share class offered by
American Funds is only available to investors in retirement plans. Even though we’re also looking at
the lowest-cost version of funds from Vanguard and DFA, their fees don’t increase as drastically
across share classes as is the case with American Funds. Moreover, American Funds has a variety of
other share classes that it claims allows it “to compensate your financial professional for helping you
decide which funds are right.”
While the gap between the expense ratios of the lowest-cost and highest-cost funds in share classes
from DFA and Vanguard can typically be measured by counting basis points on the fingers of your two
hands, the same gap between the American Funds share classes can be more than 1.2 percentage
points. And some of the share classes come with sales charges, deferred sales charges or hefty 12b-1
fees (up to 1%).
With this very important caveat in mind, the following is a summary of the data in the above table:
Of the three asset classes for which there are comparable DFA funds, offerings from American
Funds provided a higher return in one of them.
Of the five asset classes for which there are comparable Vanguard funds, offerings from
American Funds provided higher returns in four of them, and there was a tie in the fifth.
An American Funds portfolio equal-weighted in the three asset classes for which there are
comparable DFA funds returned 7.3% a year. The portfolio’s average expense ratio was 0.47%.
A DFA portfolio, equal-weighted in those same three asset classes, returned 7.2% a year,
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underperforming its counterpart American Funds portfolio by 0.1 percentage point a year. The
portfolio’s average expense ratio was 0.26%.
An American Funds portfolio equal-weighted in the five asset classes for which there are
comparable Vanguard funds returned 6.6% a year. The portfolio’s average expense ratio was
0.48%. A Vanguard portfolio, equal-weighted in those same five asset classes, returned 5.3% a
year, underperforming its American Funds counterpart by 1.3 percentage points. The portfolio’s
average expense ratio was 0.17%.
Factor analysis
We’ll now take another look at American Funds’ performance using the analytical tools and data
available at Portfolio Visualizer. The table below shows the results of a three-factor (beta, size and
value), four-factor (adding momentum) and six-factor (adding quality and low beta) analysis of the
firm’s domestic funds.
Factor analysis provides important insights, showing the sources of returns for each fund. For
example, Morningstar classifies each fund based on the fund’s holdings in each of its nine style boxes.
Thus, during periods when value outperforms growth, growth or blend funds could appear to be
generating alpha relative to a (pure) index fund in the same style box while actually generating negative
alpha based on its holdings (which include value stocks).
Data in the table below covers the period from June 2002 through February 2015. The t-stats are in
parentheses.
Page 5, ©2016 Advisor Perspectives, Inc. All rights reserved.
ThreeFactor
Annual
Alpha (%)
FourFactor
Annual
Alpha (%)
SixFactor
Annual
Alpha (%)
Fund
Symbol
Fundamental Investors R5
RFNFX
1.0
(1.1)
0.9
(1.0)
0.8
(0.9)
Investment Company of America
RICFX
0.4
(0.6)
0.5
(0.7)
0.1
(0.1)
AMCAP
RAFFX
0.4
(0.4)
0.6
(0.8)
0.8
(0.9)
Growth Fund of America
RGAFX
0.6
(0.8)
0.5
(0.6)
1.5
(1.9)
New Economy
RNGFX
0.7
(0.5)
0.9
(0.8)
2.7
(2.2)
American Mutual
RMFFX
0.9
(1.3)
1.0
(1.4)
0.0
(0.0)
Washington Mutual
RWMFX
0.3
(0.3)
0.5
(0.6)
-0.2
(-0.3)
0.6
0.7
0.8
Average
When we look at the three-factor analysis, we find that all seven of the American Funds offerings
generated annual alphas. However, none of those alphas were statistically significant at the 5% level.
The average annual alpha was 0.6%.
When we examine results from the four-factor analysis, we also find that all seven of the American
Funds offerings generated alpha. Again, none of that alpha was statistically significant at the 5% level.
The annual alpha was 0.7%.
When we include all six factors, we find that five generated annual alphas, one of which was
statistically significant at the 5% level. The average annual alpha was 0.8%.
At this point, I normally include a caveat warning readers that the returns data I have presented is all
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pre-tax, and the higher turnover of actively managed funds generally creates a significantly higher
burden when it comes to taxes. However, using Morningstar data, we discover that the average
turnover of these seven American Funds offerings was an index-like 25%. While that remains higher
than the 6% average turnover rate of the five Vanguard funds we examined, it’s still pretty low. The
average turnover rate of the three funds from DFA that we evaluated was about 8%.
An enviable record
The American Funds family of mutual funds certainly has produced an enviable record, whether you’re
comparing performance to actively managed or passively managed funds. They outperformed similar
Vanguard funds by 1.3 percentage points a year and basically matched the performance of comparable
DFA funds (underperforming in two of the three asset classes, but outperforming by 0.1% from a
portfolio perspective).
There’s a lot about the firm to admire. It keeps expense and turnover ratios relatively low. And, like I
mentioned previously, it doesn’t rely on star managers that can leave the firm. What’s more, its
managers make significant investments in the funds they run. In addition, factor analysis demonstrates
that they tend to avoid the “style drift” which can cause investors in actively managed funds to lose
control over their asset allocations and, as a result, the risk of their portfolio.
If one had to choose an actively managed fund family, this would be a good choice.
A problem for American Funds, and an issue for their investors, is that the hurdles to achieving alpha
are growing. One large hurdle the firm faces is a direct result of its own success. They now have
almost $1.3 trillion in assets under management, up from less than $1 trillion only four years ago.
A growing asset base creates an ever-higher hurdle for active managers because either the cost of
trading can increase (market impact costs rise) or they are forced to diversify more (and become closet
indexers).
Academic research continues to convert what once was alpha into beta, the pool of victims that can be
exploited has collapsed, competition has gotten much tougher and the supply of capital chasing alpha
has exploded. Those four hurdles are the focus of my latest book, “The Incredible Shrinking Alpha,”
which I co-authored with Andrew Berkin, the director of research at Bridgeway Capital Management.
With that being said, to determine if there has been any deterioration in American Funds’ ability to
outperform, we can look back at the firm’s performance data over the last five years and then compare
it to the performance data for the full 15 years.
Five Years Ending June 12, 2015
Page 7, ©2016 Advisor Perspectives, Inc. All rights reserved.
Symbol
Annualized
Return (%)
Fundamental Investors
RFNFX
15.4
Investment Company of America
RICFX
15.2
Fund
U.S. Large Blend
American Funds Average
15.3
DFA U.S. Large Company
DFUSX
16.2
Vanguard Institutional Index
VINIX
16.3
AMCAP
RAFFX
17.3
Growth Fund of America
RGAFX
16.0
New Economy
RNGFX
18.3
U.S. Large Growth
American Funds Average
Vanguard Growth Index
17.2
VIGIX
17.5
American Mutual
RMFFX
14.5
Washington Mutual
RWMFX
16.0
U.S. Large Value
American Funds Average
15.3
DFA U.S. Large Cap Value
DFUVX
17.1
Vanguard Value Index
VIVIX
15.4
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Foreign Large Growth
Europacific Growth
RERFX
9.9
Vanguard International Growth Admiral
VWILX
10.6
New World
RNWFX
6.9
DFA Emerging Markets
DFEMX
3.8
Vanguard Emerging Markets
VEIEX
3.8
Emerging Markets
The following is a summary of the data in the table above compared to the results of the full 15-year
period:
The results for DFA funds and the American Funds were identical. Comparable DFA funds
outperformed in two of the three asset classes, but the American Funds portfolio outperformed
by 0.1 percentage point.
Relative to the Vanguard funds, the American Funds’ results were quite different. For the 15-year
period, comparable Vanguard funds didn’t outperform in any of the five asset classes, although
there was one tie. But over the last five years, offerings from American Funds underperformed in
four. However, the American Funds portfolio still outperformed the Vanguard portfolio, though by
a much smaller amount (0.2% for the five-year period versus 1.3% for the 15-year period).
For taxable investors, even though the turnover of the American Funds offerings we’ve used in our
analysis is low for an active manager, it was still about 20% higher in this period than for the
comparable funds from DFA and Vanguard. Given the firm’s slight advantage in pre-tax
outperformance (0.1 percentage points versus DFA and 0.2 percentage points versus Vanguard), that
higher turnover easily could have resulted in lower after-tax returns.
The bottom line is that there was the slimmest margin of outperformance versus the DFA funds (while
underperforming in two of the three asset classes) in both periods, and the outperformance gap
relative to the Vanguard funds shrunk from 1.3 percentage points to a bare 0.2 percentage points
(while underperforming in four of the five asset classes).
Consistent with both the historical evidence on the ability of active managers to maintain
outperformance and the evidence that the hurdles to generating alpha are getting higher and higher for
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the overall industry, the performance advantage maintained by American Funds has shrunk, and the
recent slim advantage could even turn negative for investors in share classes with higher expenses. It
remains to be seen whether the firm can continue to generate outperformance.
Larry Swedroe is director of research for the BAM Alliance, a community of more than 150
independent registered investment advisors throughout the country.
Page 10, ©2016 Advisor Perspectives, Inc. All rights reserved.