Watch CBSN Live

American Funds: Does It Add Value?

When we discussed whether AllianceBernstein provided value to investors, I was asked about American Funds. Let's see how the company has done.

With $973 billion in assets under management at the end of last year, American Funds is the second largest fund group in the nation behind Vanguard. It's one of the most popular choices of active investors, and for some pretty good reasons. First, its fees are relatively investor friendly (at least for an active manager). Second, it doesn't rely on "star managers" who can pick up and leave. Instead, it relies on a team of managers. Third, it tends to stick very close to its knitting, avoiding style drift which causes investors to lose control over the risk of their portfolios. And finally, it became one of the largest companies because its track record was good.

The company also devotes considerable resources to research, noting on its Web site that it has more than 200 investment professionals (speaking more than two dozen languages) traveling the world.

So let's see if all those resources and efforts have led to outperformance against passive alternatives. We will compare the returns of nine of the American funds to the returns of similar index funds from Vanguard and similar passively managed funds from Vanguard and DFA. The period is the 10 years ending April 11.

It should be noted that the average return of American's U.S. large-cap growth/blend funds was 4.8 percent, and the average return of the firm's U.S. large-cap value funds was 4.7 percent.

If we assume investors earned the average return of American's funds in each of the four asset classes, and equal weighted the four asset classes, the American Funds investor would have earned 7.7 percent. An investor in the four DFA funds would have earned 8.1 percent. In the three asset classes that Vanguard had similar index funds, both American and Vanguard returned 7.7 percent. In neither case do we have evidence of overall outperformance.

While the American Funds may have outperformed in the past, accounting for their sterling reputation, one of the problems for active managers is that their very success contains the seeds for their own destruction. Asset bloat increases the already difficult hurdles active managers have to overcome to add value. They either incur greater market impact costs as they trade larger positions, or they have to diversify more, turning into a closet index fund.

Perhaps it's the evidence presented above that explains why American has experienced greater outflows (more than $80 billion through February) than any other family over the past two years.

More on MoneyWatch:
Does AllianceBernstein Add Value? Should You Add Gold to Your Portfolio? TIPS Update for 2011 Why Concerns About Diversification Are Overblown 3 Problems with Investing in International Real Estate
Three ways I can help you become a wiser investor:

View CBS News In