American Funds Smallcap World may be big, but its deep management team, low fees, and respectable long-term results earn it a Bronze rating.
By Andrew Daniels, CFA, CMA | 02-11-18 | 05:03 AM | Email Article

The following is our latest Fund Analyst Report for  American Funds Smallcap World . Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

Andrew Daniels, CFA, CMA, is a senior manager research analyst for Morningstar.

American Funds Smallcap World's deep management team and low fees make it a solid option for global small-cap exposure. It earns a Morningstar Analyst Rating of Bronze.

In the liquidity-constrained arena of global small-cap investing, the fund aims to circumvent its girth by dividing its $40 billion asset base between 14 managers, who independently run sleeves. The managers are an experienced group, averaging 26 years of industry experience, 22 of those with Capital Group, the parent of American Funds. Overall, American Funds' multimanager approach is a systemic strength; this and strong analyst benches limit key-person risk.

The multimanager approach also lets the managers play to their strengths. Any stock with a market-cap below $6 billion is fair game. Provided that 80% of overall fund assets are invested in stocks with market-caps below $6 billion, managers can hold on to their picks until market caps hit $48 billion. With their distinct styles, the managers can invest in their best ideas or hold cash and wait for compelling opportunities. Meanwhile, the combination of separately managed sleeves enhances diversification and mutes the fund's overall volatility to a degree.

The fund has long had a growth tilt, making the MSCI All-Country World Small Cap Growth Index a more appropriate bogy than its primary prospectus benchmark, the MSCI All-Country World Small Cap Index. The fund has a respectable, but not stellar, long-term record. During the trailing 15-year period ended January 2018, the fund's 12.5% annualized gain fell short of the MSCI ACWI Small Cap Growth's 12.7% gain.

That growth-orientation, combined with a heavy emerging-markets exposure, helped the fund deliver strong 2017 results. Its 26.8% return for the year outpaced 63% of its world small/mid-stock peers. It's worth noting, however, that downside protection has been a problem for the fund at times, such as during the 2007-09 crisis.

Overall, the fund benefits from an experienced management team and low fees. In a category with limited passive options, this fund is worth considering.

Process Pillar: Positive | Andrew Daniels, CFA, CMA 02/08/2018
The fund's divide-and-conquer approach earns a Positive Process rating.

In the liquidity-constrained arena of small-cap investing, the fund aims to circumvent its girth by dividing its $40 billion asset base between 14 managers and two analyst teams. Their independently run portfolios range in size between $500 million and $3 billion. Those are reasonable levels, given the fund's global mandate and its focus on stocks with a market cap up to $6 billion. New purchases have to be under that cap, as do 80% of the fund's overall assets. Provided the latter guideline is followed, managers can hold on to picks until their market caps hit $48 billion.

American's multimanager approach also lets the managers play to their strengths. Mark Denning and J. Blair Frank both run fairly concentrated portfolios, but Denning tilts toward value and Frank toward growth. With their distinct styles, the managers can invest in their best ideas or hold cash and wait for compelling opportunities. Meanwhile, the combination of separately managed sleeves enhances diversification and mutes the fund's overall volatility to a degree. That's important here, as managers can invest significantly in emerging-markets names. High turnover, however, is frowned upon. The managers' long-term perspective allows them to buy stocks that may take several years to work out, rather than worrying about a near-term catalyst to quickly propel returns.

The fund holds a diversified portfolio of roughly 500-600 stocks, which keeps security-specific risk to a minimum. While 80% of the fund's assets must be invested in stocks with a market cap below $6 billion, the managers regularly take advantage of the freedom to hold on to stocks until their market caps hit $48 billion. As a result, large-cap names often appear in the fund's top 20 holdings, and its average market cap tends to be well above the MSCI ACWI Small Cap's.

Despite its larger-cap tilt, the fund's risk profile is not superior to the benchmark's. That's largely because of its heavy emerging-markets allocation. Since 2009, the fund has had a roughly 15%-25% emerging-markets stake, versus about 5% to 15% for the index. Developed-markets exposure leans toward the United States but has varied from a high of about 60% of assets in late 2001 to a low of about 25% in late 2007. The index's U.S. exposure, by contrast, has tended to hover around 50%. The fund often treads heavily in consumer cyclicals and healthcare. As of December 2017, the portfolio's 35% combined stake in consumer cyclicals and healthcare was 10 percentage points more than the index's. On the contrary, the portfolio has long had limited exposure to the real estate and industrials sectors. Cash is typically 5% to 10% of assets but can reach the mid- to upper teens in extreme market conditions, like late 2007. As of December 2017, the cash stake stood at 7% of assets.

Performance Pillar: Neutral | Andrew Daniels, CFA, CMA 02/08/2018
This fund's respectable--but not stellar--performance record earns it a Neutral Performance rating.

During the trailing 15-year period ended January 2018, the fund's 12.5% annualized gain fell short of the 12.6% and 12.7% respective gains of the MSCI ACWI Small Cap and MSCI ACWI Small Cap Growth indexes, but it did beat 83% of its world small/mid-stock peers. The fund has managed to keep volatility in check, so its Sharpe ratio of 0.71 during the same period matched both indexes. While the fund outperformed the MSCI ACWI Small Cap Index in 55% of the 121 rolling five-year periods in the past 15 years, it only beat its more-appropriate bogy--the MSCI ACWI Small Cap Growth Index--44% of the time.

It's worth noting that downside protection has been a problem for the fund at times. In the 2007-09 credit crisis, a heavy non-U.S. stake contributed to the fund's 61.5% peak-to-trough cumulative loss, which underperformed the MSCI ACWI Small Cap Index by 1.4 percentage points. Its hefty emerging-markets stake was the culprit in 2011.

The fund turned in a solid 2017: Its 26.8% return topped the MSCI ACWI Small Cap Index's 23.8% gain and surpassed 63% of its world small/mid-stock peers. The fund's growth leanings, as well as its hefty emerging-markets exposure, buoyed results for the year. Specifically, strong-performing picks in the U.S.--such as Kite Pharma--and in India contributed to results.

People Pillar: Positive | Andrew Daniels, CFA, CMA 02/08/2018
This fund earns a Positive People rating, reflecting its parent company's systemic strengths as well as management's experience, ability, and aligned interests.

Capital Group, the parent of American Funds, evenly divides these assets between international management teams from subsidiaries Capital Research Global Investors and Capital World Investors. Gregory Wendt heads up CRGI's team, which includes Mark Denning, Claudia Huntington, and J. Blair Frank, among others. CWI's team is headed by Jonathan Knowles and includes such managers as Brady Enright, Bradford Freer, and Andraz Razen. The managers, based in the U.S., United Kingdom, and Asia, each oversee a separate sleeve of the portfolio. Wendt and Knowles also help to ensure that the managers' largely growth-tilted investing styles complement one another.

Overall, the team is quite experienced. The managers average 26 years of industry experience, 22 with Capital Group. The CRGI and CWI teams are each supported by about 50 analysts; and each analyst group oversees its own slice of the portfolio. American Funds' multimanager system, coupled with deep analyst benches, limit key-person risk.

All 14 managers invest in the strategy alongside fundholders, including seven with more than $500,000 invested. This helps align management's interests with investors'.

Parent Pillar: Positive | 03/01/2017
With roots tracing to 1931, Capital Group has long been a standard-bearer in asset management. Widely known in the United States for its American Funds open-end lineup, the active manager boasts some of the industry’s more reliable equity and allocation offerings. The firm’s multimanager system is key to its success. Dividing each fund into independently run sleeves lets managers invest in line with their styles, enhancing diversification and reducing volatility of the overall portfolio. The funds’ analyst-led research portfolios help develop the next generation and recruit top talent with the promise of running money from the start. The result is an investment culture marked by lengthy tenures, strong manager co-investment, and competitive long-term records.

Capital Group has improved its fixed-income approach through greater coordination and the addition of veteran managers, but the firm still must show it can achieve the kind of excellence in that asset class that it has with equities. Capacity monitoring, a perennial issue given the funds’ massive asset bases, could become a more pressing concern if the firm’s efforts to grow its business in Europe and Asia succeed or if U.S. fund flows shift back to active management. In the meantime, investors benefit from Capital Group’s modest fees, consistent results, and sound stewardship. The firm earns a Positive Parent rating.

Price Pillar: Positive | Andrew Daniels, CFA, CMA 02/08/2018
Low fees earn this fund a Positive Price rating.

The fund's front-load A shares hold nearly 60% of assets, charge 1.07%, and earn a Morningstar Fee Level of Low. By comparison, the median net expense ratio for the world-stock front-load peer group is 1.25%. It's worth noting that the fund's fees are more competitive when measured against the roughly 20 world-stock peers with average market caps below $10 billion. For example, the A shares had the lowest price tag among front-load options within that group.

In all, 13 of the fund's 17 share classes sport Low or Below Average fee levels versus similarly distributed rivals. Investors also benefit from modest trading costs. The fund's low fees give it a built-in advantage.

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Andrew Daniels, CFA, CMA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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