American Funds loser in passive shift

More than any other mutual fund company, American Funds is bearing the brunt of investors' latest infatuation with passive investing.

Index mutual funds took in a record $76 billion in 2011 and exchange-traded funds, which are predominantly passive, scored another $121 billion. Actively managed funds, meanwhile, lost about $9.4 billion, according to Morningstar Inc.

That change in preference has spelled disaster for American Funds, which grew to become the second-largest fund family, with more than $854 billion in assets, on the strength of its active management.

Last year, American Funds experienced net outflows of $81 billion, up from $18 billion in 2008. For a different perspective on American Funds' problems, consider this: With $31 billion in net outflows, the company's flagship mutual fund — American Funds Growth Fund of America — had more outflows in 2011 than all the funds at any single company.

In total, since the end of 2007, American Funds has shed about 15% of its assets.

It doesn't help that American Funds' performance hasn't been consistent year in and year out. Last year, the company's average mutual fund outperformed 65% of its peers, up from 43% in 2010.

“Some of our funds have not performed as well as we would like in the short term,” said American Funds spokesman Chuck Freadhoff. “We feel that the way we manage money has produced solid returns over the long term and we're not going to change that.”

The company's underperformance — whether it be long term or not — might have caught many investors by surprise, said Kevin McDevitt, an analyst at Morningstar.

“Advisers may have had unrealistic expectations that American Funds would hold up in any market because of how they did in the early 2000s,” he said. “They didn't do as well in the last bear market and some of the outflows are a hangover from that.”

The struggles of active managers aren't exactly new.

In each of the past 10 years, more than half of all active equity managers have outperformed their benchmarks only four times, and in none of those years did more than 63% do so.

Long-term performance hasn't been much better. Over the past five years, only 48% of active equity managers have had better total returns than their benchmarks, according to Lipper Inc.

Other giant fund families such as Fidelity Investments and BlackRock Inc. have been building their index fund lineups over the past year. Fidelity added five index funds, bringing its total to 13. Fidelity's index mutual funds had inflows of $1.6 billion, while its actively managed funds lost about $29 billion.

The Charles Schwab Corp. also is making a big push for index mutual funds. It plans to launch an index-fund-only bundled 401(k) product this quarter.

Don't expect American Funds to go the indexing route, though.

“We don't feel that over the long term, investors will do as well with a passive investment as they will active management, and we have the long-term track records to back that up,” Mr. Freadhoff said.

Client demands aren't falling on deaf ears at American Funds, however.

The firm is readying its first major product launch in more than a decade. Eight funds-of-American Funds will be launched in May, geared around investment goals, such as growth, income or tax preservation, rather than asset classes. The funds will offer a one-stop shop for manager diversification at American Funds.

Jason Kephart writes for InvestmentNews, a sister publication of Pensions & Investments.