Virtually every investor knows by now that the average actively managed mutual fund fails to beat its benchmark. A variety of studies have come to slightly different results, but about two-thirds of actively managed funds fall short of their index.
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That has led to a long-standing question: Can individuals or, for that matter, professional investors identify funds that will beat their benchmarks in the future? (I stress the word future because it's a piece of cake to spot funds that have beaten their bogeys in the past.)
The American funds, the nation's largest actively managed fund group, have now entered the fray with a provocative study. It asserts that the American funds have, for the most part, beaten their indexes over the long term. And it argues, convincingly, that they may well continue to do so.
If you're a do-it-yourself investor, you may not be terribly familiar with the American funds. That's hardly surprising. You can only buy them through a broker or adviser (or a workplace retirement plan), and the fund firm's salespeople usually communicate only with those kinds of intermediaries. American officials and fund managers almost never talk with the media, which makes the new PR offensive all the more interesting.
But if you look at the pattern of money flowing into and out of the funds, you'll understand why they decided to "go public." The American funds have lost more than $200 billion in assets over the past few years. The firm is still huge, with $1 trillion under management, but it's hurting.
At first blush, the flood of redemptions is puzzling because the American funds are so good. The stock and balanced funds have, for the most part, beaten their relevant indexes over most periods. The study includes the firm's Class A shares over rolling one-, three-, five- and ten-year periods from 1934 through 2012. Over those periods respectively, 57%, 62%, 67% and 73% of the time the funds, in aggregate, topped their benchmarks. (Rolling periods represent different stretches of time. For example, rolling 12-month returns would look at returns from September 30, 2012, through September 30, 2013; August 30, 2012, through August 30, 2013; and so on.)
More-recent performance—over the past ten years—is even more impressive. The study also looked at rolling one-, three-,and five -year periods, as well as the ten-year period ending last December. In those four spans respectively, 58%, 69%, 77% and 92% of the time the funds, in aggregate, beat their benchmark.
Tom Lloyd, a Capital Group vice-president who coauthored the study, says he doesn't expect the funds to beat their benchmarks over every short-term period. It's over the long term that the funds have excelled, he says. He's right.
Then why are so many people dumping their American funds? Russel Kinnel, director of mutual fund research at Morningstar, offers a compelling explanation that starts with the 2000-02 bear market, during which the American funds held up remarkably well.
After the downturn ended, Kinnel says, the company "ramped up its sales operation." The American funds have always been good about touting their long-term record, not short-term performance. But many advisers, brokers and clients inferred, "Hey, these guys are bear-market-proof."
The funds recorded massive inflows from 2003 through 2007, a period of generally solid stock-market performance. Assets peaked in October 2007 at $1.2 trillion—more than in any other fund firm, if you exclude money markets.
Unfortunately, the devastating decline that began on October 9, 2007, was much broader than the 2000-02 bear market. Some sectors managed to advance during the earlier slump. But in the 2007-09 bear market, during which Standard & Poor's 500-stock index plunged 55.3%, there was no place to hide. The American stock and balanced funds performed about in line with or even a little better than their benchmarks, but many investors, particularly new ones, were deeply disappointed. What's more, the American bond funds failed to keep up with their benchmarks.
The firm is contrite about its bear-market performance. "We know we disappointed people," says spokesman Chuck Freadhoff. "We disappointed ourselves. People had expectations that we'd be recession-proof. We didn't meet those expectations."
Today, the shoe is on the other foot. All the buzz is about index funds and exchange-traded funds. Most ETFs track one index or another, and some follow indexes that were invented solely to be used by an ETF. Hardly anyone wants to hear about actively managed funds.
The people in charge at the American funds are trying to stem the bleeding—and they have a good story to tell. Managers and analysts often stay at the company throughout their careers. Their funds have always charged below-average fees. Of course, if you buy one of the funds through an adviser or broker, you'll also have to pay a sales charge or an asset-based management fee.
Studies have found that low costs are the best predictor of superior fund returns. The second-best predictor is good long-term, risk-adjusted returns under the same manager or group of managers. Morningstar has also found some predictive ability in its subjective measure of corporate culture. In all of these areas, the American funds excel.
In short, I believe American is the best large fund family that specializes in actively managed funds. My favorite American funds are Fundamental Investors (ANCFX), New World (NEWFX) and New Perspective (ANWPX). I don't care for Smallcap World (SMCWX), and I'm not a fan of American's bond funds. But all the rest of the choices are solid.
Steven T. Goldberg is an investment adviser in the Washington, D.C. area.