Chuck Freadhoff, spokesman for American Funds, responded to my letter.  We had a good conversation and, while we still disagree on the value (or lack of it) of active management, we agree on some things - that a long-term focus is essential to investing success and that the right advisor relationship is key.  He also sent me a large package of data on their funds.  In upcoming articles, we will examine the performance of some of the funds through the lense of multifactor regression analysis.

American Funds is, as we briefly discussed in the previous article, a victim of its own choice of sales channel.  During the 2001-2002 bear market, many of their funds did better than the averages.  This became a simple selling point for the legions of brokerage salespeople that work for firms like Edward Jones (the largest American Funds sales outlet).  They sold the American Funds as a product based on past performance and their target market - the middle income and mass affluent - couldn't get enough of them.  The growth that they experienced from 2003-2007 propelled American Funds to one of the three largest fund companies in the world. 

Most actively managed funds underperform their benchmarks over time.  Whether it's due to bad luck or lack of skill, returns tend to revert to the mean.  When American Funds underperformed their benchmarks for just a short period of time (which is not at all unexpected), the outflows became a torrent.  The salesmen looked for other products with great short-term past performance to replace them.  Undoubtedly, a lot of the money went into gold stocks, bonds, or whatever asset class was hot at the moment.  This is disastrous for fund managers because huge outflows trigger forced sales of positions that can generate capital gains.  Large capital gains distributions in a year when the fund values also declined creates more unhappiness - and more redemptions.  The result is a vicious cycle. 

We refer to this method of selling a product as the "retail investment channel".  In contrast, Dimensional Fund Advisors (DFA) chooses not to offer its funds to retail investors through brokers/salesmen.  Even during difficult markets, flows into and out of DFA's funds are consistent - and almost always positive.  We posted a previous article on this subject here.  It's a huge advantage for their investors, but one that isn't obvious.