The American Funds Advantage?

I was forwarded an article that American Funds published touting the superiority of its funds relative to index strategies. The piece contains statements like this: “Some investment managers, American Funds among them, have distinguished themselves with a proven track record of consistently outpacing broad market returns.” And other fabulous statements like this: “Obviously, some are playing at a higher level, and using the average to characterize an entire industry obscures the fact that there are investment managers that have consistently added value over a variety of market cycles, including American Funds.

First point: love the modesty. I found myself being reminded that this was a piece by American Funds roughly every eight words. Second, this piece is illustrative of the type of half-truth analysis that permeates the financial services industry. While it’s true that many of American’s U.S. equity-oriented funds have outperformed the S&P 500, in 2013, that statement is basically devoid of any analytical depth.

At the very, very, very least, to test the claim that a fund or fund complex is adding alpha, the returns need to be examined relative to Eugene Fama and Kenneth French’s three-factor model that adjusts for any tilts that a fund might have toward small-cap versus large-cap or value versus growth. If this analysis shows significant positive alpha, then you can debate whether a fund manager or fund company possesses skill. When you apply this analysis to American Funds’ U.S. equity funds, however, that’s not what you find.

I pulled monthly returns data from Bloomberg from January 1980 through August 2013 for the seven funds that American compared with the S&P 500 in its piece (not all the funds had data for the full period, so I worked with the most data that I had for each). Below are the results from running the funds through the three-factor model.

These results show that while alpha has been positive at a bit shy of four basis points per month, it wasn’t statistically significant for a single one of the seven funds. Further, the analysis shows that the vast majority of what is driving the risk and return of these funds is attributable to generic exposure to the equity market, a focus on large companies and a slight tilt toward value stocks rather than stock-picking skill.

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