Another recent article in Investment News addressed outflows from American Funds due to real or perceived performance issues. In the article, American Funds spokesman Chuck Freadhoff stated "We don't feel that over the long term, investors will do as well with a passive investment as they will active management, and we have the long-term track records to back that up."

We disagree with Mr. Freadhoff, so we looked for the "long-term track records" that he mentioned. In doing so, we found this document. At first glance, it looks impressive. But, upon further examination there are some glaring issues. First, the performance numbers on the first page don't take sales loads into account. That's misleading, since most investors in these funds pay them. At least that is disclosed at the top of the page and the second page contains load-adjusted returns. A bigger issue, however, is comparison to inappropriate benchmarks. For example, comparing value funds to the S&P 500 Index (dominated by growth companies and, at best, a blend of growth and value). American Funds could have chosen a value index, like the Russell 1000 Value, but that wouldn't have made the comparison look as good. Even more egregious is the comparison of their emerging markets fund to a world ex-US index instead of an emerging markets index that would have shown that it underperformed. This is very misleading.

So, we sent Mr. Freadhoff the following letter. If anyone at American Funds responds, we'll follow up with an analysis. I'm not holding my breath, though. The silly thing about all of this is that the long-term returns of most American Funds offerings really aren't that bad - at least, in comparison to their actively managed peers. Retail investors and retail distribution channels are fickle and tend to place far too much emphasis on short-term performance. American Funds is a victim of that flawed psychology. Their defense of their long-term performance is perfectly valid, but they didn't need to make misleading inappropriate comparisons to bolster it.

January 23, 2012

Dear Mr. Freadhoff:

In a recent interview with Investment News, you stated that “we don't feel that over the long term, investors will do as well with a passive investment as they will active management, and we have the long-term track records to back that up.”

We believe in passive management and disagree with your statement, but would like to be objective in our analysis. Can you please provide us with the long-term track records that you referred to in the Investment News article? So far, all that we have found is a document produced by American Funds for the ten year time period ending December 31, 2010 that used benchmarks that, in many cases, do not appear to be the best fit or appropriate for the style of the fund.

I have enclosed a copy of this document. Has this been updated through the end of 2011? Why were your value funds (American Mutual Fund, Washington Mutual Investors Fund, Capital Income Builder, The Income Fund of America) compared to the S&P 500 Index when a more appropriate comparison could have been made to a value index? Is it because the poor performance of the S&P 500 over the past ten years as compared to the Russell 1000 Value Index made the fund performance look better? Was the S&P 500 actually a better statistical fit for all of these funds?

Why was your New World Fund, which invests in emerging markets, compared to the MSCI All Country World Ex USA Index instead of an emerging markets index? Is it because it underperformed the MSCI Emerging Markets Index over this time period?

I look forward to your response.

Regards,

J. Brent Everett

Chief Investment Officer

cc: Jason Kephart, Investment News