American Funds Examines What Makes a Fund Outpace Others

Three factors are critical in selecting retirement investments.

Recent market volatility has led many investors—especially those nearing or in retirement—to consider how resilient their mutual fund investments may be during market downturns.

A new study published by American Funds identifies three critical factors for selecting retirement investments: a low expense ratio, high manager ownership and a low downside capture ratio, which measures how a fund has fared relative to the market during downturns. The study found that over the last 20 years, actively managed equity funds sharing these three factors significantly outpaced indexes and active peers in a withdrawal scenario.

The study examined actively managed U.S. and foreign large-cap equity funds, moderate allocation funds (a mix of U.S. stocks and bonds) and world allocation funds (a mix of global stocks and bonds), as categorized by Morningstar. After accounting for regular withdrawals, funds sharing the three critical factors collectively outpaced indexes over the last 20 years, a period that includes the dot-com and 2008 financial crisis downturns, the research showed. The same was true when looking at rolling 10-year periods within that same time frame.

Market downturns can be particularly harmful to retirees because they are drawing regular income from their portfolios and, without a salary to make up for losses, they could suffer serious setbacks.

“One of the keys to retirement investing is doing better in bad times,” says Rob Lovelace, portfolio manager and senior member of Capital Group’s management committee. “People need to hold more equities to generate stronger long-term returns for a retirement that can last decades. But stocks introduce more volatility than bonds, and investors need to think about downside resilience.”

NEXT: Generating 85% more wealth.

“Key Steps to Retirement Success: How to Seek Greater Wealth and Downside Resilience” looked at a hypothetical 65-year-old retiring with $500,000 in savings in 1995, with a plan to withdraw 4% initially each year (increasing by 3% annually to account for inflation).

A portfolio split between moderate allocation funds and world allocation funds sharing the three factors would have generated 85% greater wealth than a blended index after 20 years. Importantly, this investor would have been able to withdraw a total of about $537,000 over this period—and would still have had $1.7 million left over. This portfolio of low-expense, high-ownership and low-downside-capture funds beat the index while experiencing less volatility (as measured by standard deviation) and greater risk-adjusted returns (as measured by Sharpe ratio). A similar portfolio of funds managed by American Funds would have generated 105% more ending wealth than the index, leaving the investor with $1.9 million at the end of the period.

“After years of investing during their working lives, millions of Baby Boomers are beginning to draw on these savings for their retirements,” Lovelace says. “The needs of these investors change as they move from growing their nest egg to living off of it – protecting their savings against market downturns while continuing to build wealth becomes even more important. By seeking active managers who keep fees low, have their own money in the fund and do a better job of limiting the impact of market downturns, investors who are nearing or are in retirement are, we believe, well-positioned to outpace index returns and build sustainable retirement income."

“Key Steps to Retirement Success: How to Seek Greater Wealth and Downside Resilience” can be accessed here.