We understand the confusion readers have expressed over some of the funds we’ve deemed “overlooked.” First Eagle Funds is hardly obscure, for instance, and a manager like Janus is among the best known of them all. But while we’ve always maintained fund families may enjoy a high profile, they might nonetheless contain a hidden gem not yet recognized. Solid performance and relatively low assets under management would therefore represent opportunities for advisors and clients alike.
We’ve done it again, featuring a mutual fund behemoth that will surely have some slapping their foreheads, but with a critical issue of increasing importance just over the horizon, we’re confident you’ll soon understand the method driving the madness.
American Funds (yes, American Funds) has long been known for its media silence, preferring to let stellar performance and extraordinary assets under management speak for themselves. It was therefore a surprise when the firm’s PR man, Chuck Freadhoff, called with a pitch about how American Funds is “driving the conversation in the industry.” While skeptical at first (after all, is a 747 an experimental aircraft, or a Bentley an affordable mid-size sedan?), we soon considered the benefits of labeling American Funds with the overlooked manager tag—especially when it comes to helping clients with their retirement planning.
“One of the most important decisions any plan sponsor can make or will make is ultimately the selection of their target-date manager,” Freadhoff said. “In most instances, the target-date fund is going to be the default investment option, so any participant who doesn’t proactively make a decision will be defaulted into that investment.”
It better be the right one then, Freadoff added, one that is chosen only after a thoughtful, prudent process on the part of the plan sponsor to select the target-date manager.
“Generally, that process involves an examination of the manager’s experience, the expenses of the funds, the historical results they’ve achieved and then, increasingly, an examination of the construction of the glide path and how the manager thinks about an investor’s journey through a life cycle,” Freadoff said.
With baby boomer retirement in full swing, the muted economic recovery since 2008 and more advisors recognizing the opportunity in becoming advisors-of-record on retirement plans, it’s a topical issue, to say the least.
“We have always aligned our funds to be investor-objective driven,” said Bill Anderson (left), director of retirement plan business at American Funds. “They’re based on the broad investment objectives of the underlying investor as opposed to a specific style-box approach. We’re using the exact same philosophy [for] how we think about the glide path as well.”
Three particular objectives any investor would think about when planning for retirement are the accumulation of wealth, the transition period (where they’re seeking a balance of growth and downside resilience) and, ultimately, income and preservation in the distribution phase, Anderson noted.
“In that accumulation phase, investors are trying to eliminate any shortfall risk that they may have at retirement,” he explained. “They are clearly trying to provide some level of inflation protection, but then they are also looking to avoid concentration risk, or the risk that they have too many of their eggs in one particular basket.”
It’s not uncommon, he said, to see growth stocks when investors are in the accumulation phase. During the transition phase (one in which Anderson claimed American Funds has a different approach when compared with the rest of the industry), investors begin to contemplate what the impact of market shocks might be to their retirement balance.
“They start thinking about how to manage a shorter accumulation period but with an eye on that downside resilience,” he noted. “We’re different in that as we move on our glide path toward retirement, we start to re-characterize the equity exposure in our portfolios. This is something that happens around 10 years out. So what does that mean? As we move from a more growth orientation to a growth and income orientation, we also have a healthy allocation to our equity income funds.”
The result is a higher equity exposure than the industry average, Anderson claimed, but the nature of the equities change—from growth to a dividend-paying profile. He thinks it better protects the end investor against longevity risk, and allows them to get a higher yield and “a lower standard deviation, which means less volatility. It’s a recipe for success as people think about moving through this life cycle of investing.”
So how do the numbers stack up?
Through the end of September, American Funds’ 2010 Target Date Retirement Fund (AAATX), one Anderson referred to as “arguably our most conservative,” had an equity exposure of 44.7% versus the Morningstar category of 38% with a three-year deviation of 7.37 versus 8.25.
Most importantly, the three-year average total return was 9% versus 7.68% for its benchmark, with a 12-month distribution rate of 3.14 versus 2.14 for the category, or 100 basis points in additional income.
Higher equity exposure, a lower standard deviation, better performance and more income—we’re beginning to realize why the company decided to break its silence.
“As you’re getting closer to retirement and thinking about distribution and the need for income,” Anderson continued in reference to the third and final phase, “you’re getting better distribution rates because of the dividend-paying stocks.”
Great, but how specifically is this “driving the conversation in the industry,” as Freadoff initially claimed?
“There are a lot of different approaches that the industry employs,” Anderson responded. “Where we’re different is that we’re not fixated on a specific retirement date; rather, it’s about the objective of the individual investor.”
Anderson added, “It’s the recognition that this is the life cycle that investors go through—these accumulation, transition and distribution phases—and it’s going to be unique for every investor.”
Whatever it is, it appears to be working.
“All of the funds [in the American Funds’ Target Date Series] ranked in or near their [peer] group’s top third,” Morningstar wrote in June. “That showing hints at what investors should expect from these funds in future environments: In markets that place a premium on safety, such as 2008 and 2011, these funds should shine.”
Yet the Chicago-based research firm noted that investors should be “prepared to sit back when riskier fare does well,” citing 2009, 2010 and the first quarter of 2012 as examples.
“The series’ shorter-dated fund originally had relatively high equity allocations that caused them to struggle in 2008 and deviate from those patterns,” Morningstar continued. “However, the investment committee toned down those allocations in late 2009, which should help the funds to hew better expectations going forward.”
Add to that “highly competitive fees for an actively managed, broker-sold series, and investors looking for those characteristics should continue to be well-served here.”
That’s pretty much in keeping with what Anderson said. Truth be told, we’re just glad their finally saying anything at all.