America's Hottest Fund Company Focus on the long term. Avoid fads. Keep expenses low. It may not sound exciting, but it works for American Funds
(MONEY Magazine) – The folks at American Funds would be horrified to be called a hot fund company. The 73-year-old money-management firm has never sought out the attention of institutions, individual investors or the media; it avoids publicity like Atkins dieters avoid carbs. In fact, few of its 26 funds carry the American brand, and even its parent company goes by a different name, Capital Research & Management. But like it or not, the Los Angeles-based investment company has found itself in the glare of the spotlight.
Since the beginning of 2002, the unassuming giant has taken in $125 billion--more than one-quarter of the money shareholders have dumped into mutual funds. Nine of American's offerings, which are sold exclusively through brokers, advisers or other financial intermediaries, made Financial Research Corp.'s list of the 20 most popular funds in 2003. And two of its funds--Growth Fund of America and Investment Company of America--have elbowed past the storied Fidelity Magellan to become the largest actively managed equity funds.
Call it the triumph of the boringly consistent. During the late 1990s, as Janus and others were shooting the moon with triple-digit returns, American was most notable for being modestly above average. But while the bear market brought many funds to their knees, American's portfolios survived with few bruises. The majority of its large-cap equity funds handily beat the S&P 500 during the downturn; Growth Fund of America outpaced other large-cap growth funds by 17 percentage points; and Washington Mutual Investors ended the bear in the black, with total returns of 4% vs. a loss of 33% for the S&P 500.
American's status has also been bolstered by the company's clean reputation; so far it has avoided the scandals ensnaring many of its peers. "American Funds are popular with brokers because you never have to apologize for them," says fund consultant Burt Greenwald.
Now the challenge for American will be managing that success. The firm has always been big, ranking among the top five fund companies since 1990. But with $532 billion in assets, American has nearly doubled its girth in the past five years. Fourteen of its funds have more than $10 billion in assets apiece. Could American buckle under its hefty weight?
MANAGING A GIANT
Even a novice magician can pull a rabbit out of his hat once in a while; the real trick is doing it over and over again. That's what makes the American story so impressive. Sure, the company's recent outperformance is great. But what's even better is its consistently above-average performance year after year after year. Of the 24 American funds with 10-year records, 21 placed in the top 50% of their Morningstar categories since 1994; 16 are in the top 25%. For the past 15 years, Growth Fund of America and Amcap rank in the top 10% of all mutual funds.
One key to that record is American's unique management style. Typically, funds are run by either an individual or a team. At Fidelity Magellan, Bob Stansky decides what stocks to buy and sell. At Dodge & Cox Stock, 10 managers run the portfolio. But American has its own style--a multiple-manager system developed in the late 1950s by Jon Lovelace, son of firm founder Jonathan Bell Lovelace. The typical American fund has seven to nine managers, or portfolio counselors, as they're called in American Funds-speak. Unlike at the typical team-managed fund, each manager operates independently; the funds are actually run as collections of separate portfolios.
Take Investment Company of America (ICA). The bulk of the fund's assets are divided among nine managers, who each manage $5 billion to $8 billion. The remaining 20% to 25% of its assets are parceled out to 25 analysts, specialists in specific sectors. Every investment professional can invest his piece of the pie according to his view of what's appropriate for the fund. One manager may choose to concentrate in nine stocks while another diversifies across 45. One manager may be buying Microsoft just as another is dumping it. One may be loading up on dividend-rich stocks while another favors faster-growing prospects. A lead portfolio counselor makes sure the fund stays within its prospectus guidelines. (For instance, ICA can't have more than 15% of assets in foreign stocks.)
This structure makes it easier to deal with a flood of cash. When investors rush into its funds, American can quickly dole out the money to an army of managers or add another portfolio counselor if assets become too unwieldy. Having such a deep bench also means that shareholders don't have to worry about abrupt changes if one manager jumps ship or retires.
But the most important benefit of the multiple-manager system is that American's funds have avoided the fate of many megabillion-dollar portfolios: becoming index funds dressed up as actively managed portfolios. The typical holding in the $74 billion Growth Fund of America has a market value of $27.5 billion vs. $45.9 billion for the Vanguard 500 index fund. Instead of ExxonMobil and Wal-Mart Stores, the fund owns Forest Laboratories and Target. The $67 billion Washington Mutual Investors, which focuses on dividend-paying stocks, holds a stash of midcap companies with market caps of less than $15 billion, among them papermaker Weyerhaeuser. These distinctions matter. After all, it's tough to beat the market if you look like the market.
"ALL-AMERICAN, APPLE PIE"
While it's never been easy to get an interview with the top managers at American Funds, they are nearly in lockdown after all the recent attention. They don't want to talk about inflows, one-year returns or their new status as the new "it" fund company. It's hard to find fault. As they see it, focusing on the short term means losing sight of the long term. That hawklike attention on managing money--rather than on making money--is at the core of what they do. When you first visit the firm's headquarters in downtown L.A., you immediately get the sense that things are different. All of the corner offices are reserved not for the president or chairman but for nondescript conference rooms. In fact, the bigwigs' offices are utterly indistinguishable from those of other managers or analysts. That egalitarian culture has encouraged an almost cult-like loyalty--managers come, but they never leave. The average American fund manager has nearly 20 years' experience with the company or its affiliates. Turnover among investment professionals is less than 1% a year. For the people at American, it's all about the long term.
Take the firm's policy on introducing funds. From a business perspective, the best time to open a fund is when you can attract the most investors. Unfortunately for shareholders, that's usually the worst time to invest in a fund. If you had invested $10,000 in one of the 19 new technology funds that came to market in 1999, your investment would be in the red. Last year, 45 fixed-income funds were launched; since then the bond market has sputtered. American takes the view that it should open funds only when there is an identifiable need on the part of investors and value in that segment. The firm launched American High-Income Municipal Bond in 1994, when munis were in the tank, and New World in 1999, after the Asian flu had roiled Third World stocks. "Their product line is deliberately not the latest rage," says Charles Ellis, founder of investment consulting firm Greenwich Associates and author of a recent book on Capital Research. "It's straightforward, all-American, apple pie, hold hands when crossing streets, tell your mom you love her, say thank you to your friends. Corny as it is, it is what will attract investors for the long run."
American is equally adamant about keeping expenses low--the key factor in creating wealth over the long haul. The average American equity fund carries an expense ratio of just 0.8% vs. the industry average of 1.5%. That's a good deal even after you pay the load (5.75% for equity funds, 3.75% for bond funds). In fact, each of American's four share classes (which have a typical load structure for the industry) have relatively low fees. Its F shares, which can be bought without a load but have a higher 12b-1 fee, are still pretty cheap at around 0.85%.
Without a crystal ball it's hard to predict whether American can keep up the pace it's maintained for the last 10 years over the next 10. But the best mutual fund companies--the ones that deserve your money--are those that are concerned more with making shareholders money than with lining their own pockets. Actions, in this case, speak louder than numbers. And American's actions say something pretty darn good.