American Funds - Investment Insight - September 2013 - Active vs Passive investing

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American Funds statistical analysis regarding active investing and passive investing.

Text of American Funds - Investment Insight - September 2013 - Active vs Passive investing

  • 1Investment Insights September 2013

    The active advantage

    The average active manager cant beat the index. This phrase has been repeated so many times it almost seems as if its gospel. Actually, it does contain a measure of truth. Taken as a whole, on average, active managers beat their benchmarks only about half the time.

    But not all active managers are average. Some investment managers, American Funds among them, have distinguished themselves with a proven track record of consistently outpacing broad market returns.

    Although the debate over the merits of active management and passive investing has raged for quite some time, recent articles in various publications touting index investing have re-ignited the issue. Several of them have cast a negative spotlight on actively managed funds and their fees and returns.

    In this report, well look at how American Funds active equity manage-ment has provided clear advantages over index investing during every meaningful period of time for decades. We believe the study makes a compelling case for our active advantage. More importantly, we think its time to reframe the debate and to focus on investor outcomes.

    Capital Idea: The active advantage can help investors pursue better outcomes.

    Investments are not FDIC-insured, nor are they deposits of or guaran-teed by a bank or any other entity, so they may lose value.Past results are not predictive of results in future periods.

  • 2The argument for the superiority of passive, or index, investing over active manage-ment has been accepted and adopted by a significant number of academics, consul-tants and investors.

    Active management, the argument goes, is unable to outpace a respective index for a variety of reasons, ranging from the drag posed by fees to the efficient-market hypothesis. Those who adhere to that theory contend, in brief, that all information is reflected in a firms share price, making it impossible to beat the market consistently.

    But much of the literature in favor of index investing uses the average active man-ager to make the point. And indeed, in ag-gregate, U.S. equity active managers have not consistently outpaced the Standard & Poors 500 Composite Index.

    We believe this is a flawed way to frame the issue, akin to concluding that because the average person cannot dunk a basketball, no one can dunk a basketball. Obviously, some are playing at a higher level, and using the average to characterize an entire industry obscures the fact that there are in-vestment managers that have consistently added value over a variety of market cycles, including American Funds.

    To be clear, we are not defending all active management. Specifically, we are noting our persistent, long-term added value as an active manager. We believe its impor-tant to focus on the qualities associated with success, including alignment with clients objectives, low fees, experienced managers, global research, a history of out-pacing indexes and an investment culture thats built to last.

    The problem with averages

    The active-versus-passive debate has been grossly overplayed to the detriment of many fine, actively managed fund shops and to intelligent investment discourse.

    Don Phillips, Morningstar

    Investment Insights September 2013

    The active advantage

    The average active manager cant beat the index True, but not the whole story

    Data from Morningstar. Based on calendar-year returns of actively managed funds, excluding the American Funds, whose relevant benchmark is the S&P 500 Index. This universe excludes funds that fell in the Morningstar Moderate and World Allocation categories. Funds with incomplete data were removed from the analysis. For more information on filtering methodology, see General Methodology, page 10.

    Percentage of funds100%

    80

    60

    40

    20

    0

    20

    40

    60

    80

    100

    1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

    47% of the time, U.S. equity active managers outpaced the S&P 500 Index during the 20 calendar years ended 12/31/12

    53% of the time, U.S. equity active managers trailed the S&P 500 Index during the 20 calendar years ended 12/31/12

    Percentage led index Percentage lagged index

  • 3Our equity-focused American Funds have a long history of outpacing the marketDecade after decade, active management has provided investors with an advantage

    Outpaced indexes

    3,897 1,066 3,971 1,255 4,021 1,377 3,761 1,575 2,834 1,974

    Total number of rolling monthly periods 6,804 1,850 6,409 1,815 6,034 1,783 5,134 1,721 3,413 2,020

    Data from published sources were calculated internally. Numbers of periods are based on rolling monthly data for all funds reducing entry- and exit-point bias and better reflecting the range of entry points experienced by investors. American Funds represents 17 equity-focused funds, in aggregate, including: AMCAP Fund, American Balanced Fund, American Funds Global Balanced FundSM , American Mutual Fund, Capital Income Builder, Capital World Growth and Income Fund, EuroPacific Growth Fund, Fundamental Investors, The Growth Fund of America, The Income Fund of America, International Growth and Income FundSM , The Investment Company of America, The New Economy Fund, New Perspective Fund, New World Fund, SMALLCAP World Fund, Washington Mutual Investors FundSM. For each funds comparable index/index blend, see General Methodology, page 10. Past results are not predictive of results in future periods.

    Has American Funds added value? We sought to answer this question both to hold ourselves accountable and to seek a way to continually improve our approach.

    As part of an extensive new study, we analyzed the track records of all of our equity-focused American Funds. In an attempt to be as comprehensive and transparent as possible, results for every fund over every possible one-, three-, five-, 10-, 20- and 30-year rolling period (monthly basis) between December 31, 1933, and December 31, 2012, were included. The data set therefore spans virtually the entire history of the mutual fund industry.

    Our overall active success rate or the percent of rolling periods in which we outpaced the index was superior for

    each investment horizon considered, from one year to 30 years.

    Of course, American Funds track record is not perfect. Its important to acknowledge there have been times when not all of our results have been stellar and times when our funds have lagged the index.

    But the chart below shows a consistent, long-term record of our funds in aggregate outpacing market returns decade after de-cade. Indeed, overall results demonstrate that our funds have outpaced their indexes the majority of the time, and actually got stronger over longer periods.

    The record stands as a testament to The Capital SystemSM and our process of active management.

    1-year 3-year 5-year 10-year 20-year 30-year

    57%67%

    73%83%

    62%

    98%

    58% 69%

    77%

    92%

    Historical track record:Percentage of time American Funds led their indexes (19342012)

    Recent track record: Percentage of time American Funds led their indexes (1/31/0312/31/12; includes one-, three-, ve- and 10-year rolling periods ended in the last 10 years)

    A note on methodology

    We analyzed the track records of all of our equity-focused American Funds from 1934 through 2012. Our study encompassed thousands of data points and spans virtually the entire history of the mutual fund industry. In addition, a large accounting firm performed an objective validation of our methodology to ensure accuracy.

    A long history of active advantage

  • 41-year 3-year 5-year 10-year 20-year 30-year

    62% 64% 64%

    80%

    Percentage of time American Funds led their indexes in one period and repeated leadership in the subsequent period (19342012)

    60%

    96%

    Data from published sources were calculated internally. Numbers of periods are based on rolling monthly data for all funds reducing entry- and exit-point bias and better reflecting the range of entry points experienced by investors. American Funds represents 17 equity-focused funds, in aggregate. For the list of funds and their comparable indexes/index blends, see General Methodology, page 10.

    Outpaced indexes

    2,363 2,212 2,169 1,402 710 246

    Total number of rolling monthly periods 3,792 3,682 3,403 2,186 893 257

    Can you do it again?

    If an investment manager has outpaced the index in the previous period, can the manager do so again? Put another way, is the track record the result of luck or skill?

    Persistency is a measure that can help investors answer these questions. It is the percentage of time that funds continued to lead their indexes after having led in the previous period.

    The potential benefits of a track record of persistency are clear. While past results are not indicative of future returns, persistency can give investors some confidence that the manager has the potential to help them succeed in the future.

    Persistency has been relatively abundant for American Funds equity funds. More often than not, our funds have led their indexes and continued to lead in the subsequent period. Their overall persistency advantage increased over longer holding periods.

    Some critics of active management con-tend that its challenging to find managers that can continue to provide above-bench-mark returns based on past results.

    We believe persistency is a criterion that investors can use to help select managers with the potential to add value in the future. Other important criteria include alignment with clients objectives, low fees, manager t