American Funds retools approach to adviser market

By Jason Kephart

Sep 29, 2013 @ 12:01 am (Updated 10:21 am) EST

After five years of outflows across its mutual funds — to the tune of $242 billion — American Funds is overhauling its approach to working with financial advisers.

The company, which sells its funds through advisers, plans to increase its internal sales force by 25% to about 150 over the next six to eight months. American also is making a concerted effort to be more open about its processes for picking stocks and the managers behind its funds — marking a dramatic change of course for the intensely private company.

“Financial advisers expect more from managers now, and American Funds hasn't kept up,” said Janet Yang, a mutual fund analyst at Morningstar Inc. “It's a very competitive industry. You can find other managers who will give you the information you want.”

The outflows at American “have been very notable,” Ms. Yang said. “At this point, they're really just trying to change that story.”

American Funds, which is owned by The Capital Group Cos. Inc., has fallen from being the biggest mutual fund company, with $1.15 trillion in mutual funds in 2007, to being the third-largest today, with $993 billion as Aug. 31, trailing The Vanguard Group Inc. and Fidelity Investments.

Changing business model

American, for its part, denies that its latest moves are in direct response to the outflows.

“It's a renewed commitment to advisers,” said Matt O'Connor, director of distribution in North America for American Funds.

That renewal no doubt is being driven in part by the changing business models of American Funds' core customers at the wirehouses and regional broker-dealers. Advisers at those firms are moving rapidly away from traditional commission-based compensation to fee-based compensation.

Asset-based fees are expected to make up 70% of wirehouse compensation by 2016, up from 58% last year, according to a recent Cogent Research LLC study. At the regionals, asset-based fees are expected to grow to 57% of business, from 42% last year.

That shift presents complications for American Funds, which always has had the majority of its fund assets in A shares that have front-end sales loads.

“The way advisers conduct business today is just fundamentally different. The new business model has changed our interactions with advisers,” Mr. O'Connor said.

“Their expectations have gone up. They expect us to know more about them, more about their options and the platforms they use,” Mr. O'Connor said. “It's much more of a consultative conversation.”

Most industry watchers agree that it is about time American took matters into its own hands.

“They have tended to be somewhat invisible,” said industry consultant Geoffrey Bobroff.

“Now they're increasing their visibility in the marketplace,” he said. “They really need to do that.”

Even though American is just now taking steps to increase its visibility, both in the media and in the home offices of advisers, it hasn't been idle behind the scenes.

In the past few years, American has launched a series of outcome-oriented funds of funds, college target date funds for its Section 529 college savings plans, its first separately managed accounts for advisers and three bond funds. Plus, it has a new emerging-markets fund in the works.

That is a lot for a company that launched just three mutual funds during the mid-2000s when its funds were selling faster than hotcakes.

The timing of American's commitment to getting the word out about its mutual funds couldn't be better.

Active funds

The end of next month will mark the five-year span since October 2008 — the worst month of the financial crisis — and five-year annualized returns of stock mutual funds will reflect the dramatic growth since that date.

The average annualized five-year return for large-cap stock funds will jump from 0.57% to more than 10%, based on returns through the end of August, according to Morningstar.

Some predict that could lead to a resurgence of interest in actively managed stock funds.

To state its case further, American recently released a study of its own funds' performance and found that 73% of its stock mutual funds have beaten their respective indexes over the 10-year period ended Dec. 31. Over the past five-year, three-year and one-year periods, more than 60% have beaten their index.

“Our role is to advocate for the value of active management,” Mr. O'Connor said.

American's troubles began when the funds stumbled across the board in 2008, a particularly painful turn of events, given that the company had earned a reputation for being able to dodge downturns after doing so successfully during the technology crash.

The mortal performance during the financial crash, combined with American's reluctance to talk about its investment process outside the confines of its headquarters and road shows, opened the firm up to competition from other mutual fund managers, as well as index funds.

The increased transparency around its investment process, which will include detailed reports on how each funds' management team is built, should go a long way.

“They've gone so many years with so little information about the funds' holdings,” Ms. Yang said. “They're definitely moving in the right direction.”

Advisers are ready to welcome the changes with open arms.

“If they're willing to share more information and more insight into their funds, I don't see a downside,” said Melissa Hammel, managing member of Hammel Financial Advisory Group LLC, who has clients invested in several American funds.

In one sense, American is playing catch-up to Vanguard, which got a jump by remaking its sales operation to work better with the growing number of fee-based advisers. Last year, it began doubling its sales force to 220 and moving its sales representatives into the field for the first time.

Since 2007, Vanguard has had more than $600 billion of inflows, dominance reminiscent of American's glory days.

'Won't embarrass you'

When Jim Johnson, a partner at Lighthouse Financial Planning LLC, was starting out his career in the 1980s, a fellow broker told him, “If I only sold American Funds I would never have lost a client.”

Mr. Johnson has held as much as half his clients' assets in American, but today only uses a couple of its bond funds. Still, he is open to adding American's bread-and-butter equity funds again someday.

“You can give them money and they won't embarrass you,” Mr. Johnson said.

Although it is too soon to tell if the changes at American will pay off, the biggest factor in a turnaround might be out of its control, Mr. Bobroff said.

“It depends on whether or not the equity markets continue to improve,” he said. “At the end of the day, the likelihood is if the market's right, they should be a winner again.”