Capital Research and Management, which runs American Funds, is beginning to recover from the 2008 financial crisis, with outflows slowing and assets of American Funds back up to $1 trillion. Chairman James Rothenberg makes its case for active management


This American Life, In Turnaround


Capital Research and Management, which runs American Funds, is beginning to recover from the 2008 financial crisis, with outflows slowing and assets of American Funds back up to $1 trillion. Chairman James Rothenberg makes its case for active management.


“We disappointed a lot of people who had come to us from other places…. Now we seem to be back on track with results.” — James Rothenberg

How times have changed. Once the largest fund company and a darling of financial advisors, American Funds was famously reticent. The funds, run by the venerable Capital Research and Management, never advertised, and its portfolio managers refused to speak to the press, preferring to let their funds’ performance do the talking. But beginning in 2008, the funds didn’t have anything good to say. Poor performance during the financial crisis and its aftermath triggered more than $250 billion in net outflows in the past five years.The firm’s flagship, American Funds Growth Fund of America (ticker: AGTHX), has a stellar long-term record: Its 15-year average annual return of 9.3% is better than 94% of its large-cap growth peers. But the fund’s five-year annual return of 11.67%, though slightly better than the Standard & Poor’s 500’s increase, lands it in the bottom half of its Morningstar peer group.

Simply being slightly ahead of the broad indexes just isn’t good enough. American’s funds are sold only through advisors, and as they increasingly embrace passively managed exchange-traded funds to execute their own active strategies, American has decided to change its approach. Though still only broker-sold, Capital Research has slowly raised its profile to make its case for active management. A recent study it published notes that from 1934 until 2012, its funds outperformed their benchmarks over rolling 30-year periods 98% of the time.

The Los Angeles-based firm, founded in 1931, just after the most famous stock-market crash, is beginning to recover from the latest crash. Outflows are slowing, though 2013 is shaping up to be the sixth year in a row of net outflows. Even so, American Funds is back up to $1 trillion in assets. Capital is also rounding out its fund offerings and making more inroads into the 401(k) business. In a rare interview, James Rothenberg, 67, the firm’s chairman, who has worked at Capital since 1970, sat down with Barron’s on a recent visit to New York. He was frank about Capital’s subpar performance, but optimistic about its turnaround.

Barron’s: Let’s start with the headlines. In January American Funds saw its first net inflows in nearly four years. But then outflows began again. Are you concerned?

Rothenberg: Well, I’m always concerned. But I liken this to the late 1990s, during the tech bubble. We were doing well on an absolute basis, but not very well on a relative basis, and we had outflows. The bubble burst in March 2000, and our investment returns in subsequent years were very good, because we were much less exposed to the tech bubble than other money managers were. In some cases, our funds were up from 2000 to 2002. On top of that, we never got caught up in the late-trading or market-timing scandals. So we just had this enormous inflow of assets, which surprised us in its magnitude, and then we had pretty good results coming out of that. We went from annual gross sales [gross inflows] of around $70 billion to $200 billion at one point.

So what happened after the 2008 financial crisis? 

We didn’t do as well in 2008 and 2009 as we did in 2001 and 2002. As a result, we disappointed a lot of people who had come to us from other places. A lot of them decided to pick up their chips and go home. Now we seem to be back on track with results. Our overall fund performance was good in 2011 and 2012, and it seems to be good in 2013. So we think we’re coming back. But we really disappointed in 2008 and 2009. We understand that and accept it. So are we worried about outflows? Well, sure, we are always worried. But are we panicked? No.

Why didn’t you recover as quickly this time?

When we did our own analysis of that whole period, one of the things that fascinated us was that we really avoided a great deal of the mortgage problems on the fixed-income side. For instance, we didn’t have a lot of lower-rated credits. Yet we still owned a lot of the banks on the equity side—how did that happen? The information didn’t seem to flow between the fixed-income people and the equity people. We have spent a great deal of time since then integrating equity folks into the fixed-income discussions, and the fixed-income people into the equity discussions.

So you owned too many bank stocks. Why?

Yes, we did. We have a lot of funds for which current yield was, and is, a very important part of the objective. And there were only a few places where you could get significant yield. One was financials, one was oil, one was utilities, and there was a smattering of other things. So we were naturally drawn to the financials because on earnings they looked cheap, relatively speaking. The problem was that their earnings weren’t real, as we now know.

For many years, American Funds grew very nicely with the help of brokers in smaller towns and smaller cities. Is that still a key distribution channel for the firm?

We have a lot of channels. Our huge inflows in the early 2000s were driven by the then-major firms, and that market is where most of our market share has come down. They have been much more reactive to much-shorter-term results.

Do you mean the big, full-service brokers?

Yes, the wire houses. Our market share in those firms is really way down. Our market share in places like Edward Jones is still very large, and we do exceptionally well around the country, not so much just Middle America. You don’t think of Seattle as Middle America. Small, medium-size financial planners and investment companies—that’s a big part our business.

You seem to be adding to your fund lineup. Among other changes, you just added your first emerging-markets fund. Does that mark a departure from your traditional philosophy of sticking to what you know?

It’s not a dramatic change. We were early into global markets; this is just rounding out our offerings. So there is nothing dramatic about it.

What other changes have you made at the firm?

We dramatically adjusted the role of the research director. We have more than one person in that position, and we stripped out the administrative stuff that had accumulated to allow them to focus much more on working with the analysts and the investment process.

Capital Research and Management seems to be taking on a much more public role, largely in defense of active management. Why is that?

In the past few years, particularly in the retail side of the business, the world seems to have been all about asset allocation and indexing. But there hasn’t been anybody talking about active investing. So we did a study. We pretty much knew what we were going to find when we did it, but we did it.

What did the study tell you?

First, it confirms that the general principle of indexing is accurate—that is, if you use a big-enough universe, such as all mutual funds or professional money managers—on average they don’t outperform broad market returns. That wasn’t any surprise to us.

OK, but…

On the other hand, the study also demonstrated that one or more firms consistently outperformed over long periods of time. That active advantage drives bigger compounding, and therefore more asset growth for investors.

If that’s the case, why have index funds and ETFs gained so much traction?

Part of it is that the major brokerage firms have really pushed their fee-based business. And the assumption in that is that the asset-allocation piece of portfolio management is very important. From our perspective, that remains to be seen.

You’re referring to the trend of financial advisors charging a flat fee, and using low-cost products to implement their asset-allocation plan.

Right. So you, the client, give me discretion to allocate your assets. I’m using models that are changing, sometimes quite frequently. Those models are passed from the home office down to the broker. When you charge a flat fee for that asset-allocation function—somewhere between 100 basis points [1%] and 150 basis points [1.5%], depending on the size of the account—you do everything you can to keep down the costs of the products you use.

Yes, it’s no secret that part of ETFs’ appeal is that they’re cheap.

It isn’t clear that all index products and ETFs are as inexpensive as people think they are—some have surprisingly high fees. Also, not every fund out there is all that expensive. For example, many of our funds, depending on the platform, have annual fees well below 40 basis points, or 0.4%.

You just said it “remains to be seen” whether asset allocation is a bigger driver of returns than stock selection. There’s a lot of academic research that says otherwise, most of it attributing more than 90% of a diversified portfolio’s return to asset allocation, and that security selection, be it funds or individual securities, is far, far less important than most people think.

Yes. This asset-allocation and fee-based concept really focuses on asset allocation as the prime provider of any alpha, or outperformance. It is also somewhat presented as the way you would have avoided what happened during the financial crisis, but there are a few issues with that. One is that the index is going to be fully invested. So you are not being protected against the downside. And from our studies of our own performance, a lot of the outperformance over long periods of time comes on the downside. So we can give you good value long-term, lower volatility, and better downside protection.

Asset allocation can’t protect you in a down market?

In our experience, that isn’t so easy to do using asset allocation. How many asset-allocation models had 5% to 10% in gold and commodities? Has that been a good deal? What percentage did they have in bonds? Have they brought that down or kept it up? So the question really becomes: Are you going to achieve what you thought you were going to achieve over time? And that’s about downside protection when something gets out of whack, whether it is valuation in equities or interest rates getting too low.

There has been a lot of emphasis in the mutual-fund world on bringing more alternative strategies, including long-short stock-picking, to a wider investor base. Does this make sense?

These products are not necessarily inappropriate. But for the average investor, you have to take a good hard look at the costs, because if you are getting an alternative product in a ’40 Act [Investment Company Act of 1940] sleeve, that is going to be a fairly expensive. This has come up in my trustee work at Harvard, where I help to oversee the endowment. The rates of returns that were achieved by institutions like Harvard and Yale 15, 20 years ago were a heck of a lot better than the returns they’ve seen more recently. I’m not saying that there aren’t individual hedge-fund firms that have done very well. But across the whole array of firms, those rates of returns have been coming down pretty substantially.

The Bond Fund of America [ABNDX], one of your big bond offerings, is in the bottom half of its Morningstar category based on one-, three-, five-, 10-, and 15-year returns. What has caused that underperformance?

That fund, over many, many years, did reasonably well, but it did so because it used a great deal of lower-rated credits. However, it did not avoid the credit crunch that occurred in 2008 and 2009. Improving our fixed-income performance has been a big focus.

As a money manager, what opportunities look attractive?

This is a personal view, not a firm view. Despite the Fed’s announcement last month that it wouldn’t begin to taper until later this year or even possibly next year, I’m very wary of the fixed-income side of the world. My assumption is that, at some time, interest rates will go up. So as I look at valuations around the world, the place that my eye is drawn is to the developing world, which has been the least attractive region in the past 18 months. I don’t feel bad about the U.S., but I get a little worried that corporate profit margins are very high in aggregate. And the growth of the U.S. economy is modestly getting better, but it is not about to run away. So earnings may begin to be a little bit more of a problem. I’m a little more cautious than I was on the U.S. and a little more attracted to the developing world.

Thanks, Jim. 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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