15 transformational events: American Funds out, Vanguard in

American Funds and The Vanguard Group Inc. have been the two dominant mutual fund companies for financial advisers during the past 15 years. American Funds rose to prominence after dodging both the Internet bubble and market-timing scandals of the early 2000s, while Vanguard's 30-plus-year-old message of keeping costs low finally caught on with advisers after the financial crisis remade the investment landscape. Both have been most affected, however, by the shift among advisers toward fee-based investing. PHOTO GALLERY 15 transformational events The early 2000s were a tumultuous time for most mutual fund companies. After years of double-digit gains in the S&P 500, the bottom finally fell out of the market when the Internet bubble popped in May 2000. The S&P 500 fell 42% between then and October 2002. And then, just as the markets were getting back on stable footing, the industry was hit with allegations of market timing. American Funds wasn't implicated in the scandal, and — most impressively — some of its funds actually made money during the downturn. The American Funds Income Fund of America (AMCEX), for example, had a 4% return during the 2000-02 bear market. Assets at American Funds, which are available to investors only through advisers, took off after that. “You started to look at the three-year returns in the wake of that and you said, 'These guys are geniuses,'” said Josh Brown, a financial adviser at Fusion Analytics Investment Partners LLC. American Funds topped $1 trillion in mutual fund assets by 2007, from $324 billion at the end of 2002. The wheels came off in 2008, though, when American Funds failed to avoid the stock market's collapse. “In 2008, along with just about every mutual fund company in the world, we disappointed our investors because we lost ground,” said spokesman Chuck Freadhoff. Investors have pulled more than $200 billion from the company since then. “The whole pitch from 2002 to 2008 was that these guys are smart enough to know not to get caught up in a bubble,” Mr. Brown said. “You couldn't continue that pitch in 2010.” Spooked by the losses of 2008 and the potential of low returns, advisers started looking for an alternative, and they found one in Malvern, Pa., of all places. That is where John Bogle, the godfather of index mutual funds, first started preaching his mantra of keeping costs low, as that is the only thing an investor can really control. “Costs moved to the forefront after assets were beaten up so bad,” said Mitchell Reiner, chief operating officer of Capital Investment Advisors LLC. That, of course, played right into Vanguard's hands, thanks to its industry- leading index mutual fund and exchange-traded-fund business. Assets in Vanguard's Financial Adviser Services division went from just a sliver of the firm's overall assets to nearly one-third by the end of last year. In that same year, they also helped Vanguard set an industry record for inflows in a single year. And Vanguard got off to an even faster start in the first quarter this year, taking in a record $53 billion. The scary thing for other mutual fund companies is that Bill McNabb, Vanguard's chief executive, said that the firm is just getting started. “There's a lot of room to go here,” Mr. McNabb said. “This message of low-cost investing really works,” he said. “We're in the early innings of this.” Vanguard's been helped by taking a unique approach to building its relationship with advisers. Instead of talking to them about beating the market by using products, they talk to them about creating alpha through being a good steward. “The single biggest value-add an adviser can offer is steely professional discipline,” Mr. McNabb said. “Behavior finance guys will tell you all day that people act irrationally,” he said. “Advisers can serve clients very well by just keeping them disciplined.” Vanguard's also doubled its adviser-focused sales force in the past two years to help spread the Gospel of Bogle better. The increased effort has paid off, Mr. Reiner said. “They were definitely last to the party, but they're making a good effort at supporting our business now,” he said. “They are specifically interested in helping us think about our business and the environment we're currently in.” American Funds, for its part, hasn't taken the loss of assets lying down. In the last two years, it has introduced its first separately managed accounts, launched a series of funds of funds, and beefed up its 401(k) and Section 529 plan options, with collective investment trusts and target date college funds, respectively. Its biggest challenge, however, is convincing the growing wave of fee-based advisers to get on board. American Funds launched load-waived share classes of its funds over 10 years ago, but adoption has been slow. “People still think of us only as a load-based company, but we're agnostic,” Mr. Freadhoff said. “How you compensate your financial adviser makes no difference to us,” he said. “We believe you do need an adviser, and we believe in the advice model.”

Video notebook: InvestmentNews' Jason Kephart