A recent ad from American Funds caught my attention. It claimed a “superior long-term track record” with 91% of equity funds beating their Lipper peer indexes in a 10 year period. This is fantastic! In a recent article titled “86% of investment managers stunk in 2014”, CNN Money reported that 82% of active fund managers failed to beat their benchmarks over the last 10 years. So how does American Funds do it? According to the ad, it’s a “… proprietary investment process that combines independent thinking with teamwork to pursue superior results…”. But perhaps there’s another explanation, they’re exaggerating.
The 91% success rate is based on “Lipper peer indexes”, what? According to Lipper, “Lipper Active Indices enable you to benchmark portfolios against the funds you are competing with, rather than against passive indices”. In other words, instead of comparing yourself against a passive index, you can compare yourself against a group of managers that fail to beat the index 82% of the time! In one Prospectus American reported the 10 year performance of the S&P 500 at 7.67%/year and the Lipper benchmarks at 6.37% and 6.75%, that’s a significant lowering of the bar!
What happens if we compare American Funds to a “real” benchmark? Fortunately, we don’t have to because they’ve done it for us on their web site. I found 15 equity funds with at least 5 years of history, and 14 with at least 10 years. Over 5 years only 20% of funds beat the stated benchmark; over 10 years 43% beat. Over 5 years the funds underperformed by about 2.7%/year on average. Over ten years the number is better, losing only about 0.2% annually against the benchmark. But it’s still worse than an index fund (0.1% underperformance) and hardly brag worthy.
It gets worse. American Funds charges a sales charge of as much as 5.75%. The footnotes state “If a sales charge had been deducted, the results would have been lower”.
American Funds is not alone in either their lack of performance or in their tendency to imply that they can “do better”. From what I’ve seen in my relatively short tenure in this business, the number one skill of mutual fund firms is advertising and sales, not investment management. American Funds is the most audacious, but almost all firms imply that they can do something that they cannot. I’ll add my voice to the herd that has come before me and suggest you skip actively managed funds in favor of index funds.