Portfolio Construction | Capital Group


Portfolio Construction

Defined benefit (DB) plans consistently report better returns — as much as 0.9% higher per year1 — than defined contribution (DC) plans. The Pension Protection Act gave plan sponsors tools to narrow this gap, such as investment re-enrollment and target date funds (TDFs) as default investments. These have helped improve investing behavior for many participants, but what about the 63% of DC plan participants who still make their own investment decisions?2

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Get More From the Core Investments in Your DC Plan Lineups

The Capital Advantage℠ Participant Case Study

Screening for the Right Core Retirement Plan Lineup

Financial professionals generally agree that when choosing core investments for a retirement plan, it’s important to look for funds sharing certain qualities. These could include lower expense ratios, lower portfolio turnover, higher manager tenure, higher firm-level manager ownership and long-term manager incentive programs.

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Take a More Dynamic Approach to Managing Volatility in Target Date Funds

We believe that target date series should feature not only a gradual reduction in equities over time, but also a gradual shift in the nature of that equity exposure. This transition, which we call recharacterizing the equity exposure, effectively creates a “glide path within a glide path” that can help lower volatility.

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The Value of Time in 401(k) Plans

Exhibit 3: American Funds (R-3) vs. relevant index

*Some indexes do not have histories sufficient for comparison to the lifetime of certain funds. See General Methodology section below for details.

While sponsors should compare their plan’s investments at least once a year with the appropriate benchmarks and peer investments and over a series of different time horizons, the key question remains: How long should those time horizons be to ensure that the resulting decisions are prudent? 

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INVESTMENT INSIGHTS  |  September 2014  |  FEATURING Wesley Phoa & E. Luke Farrell

Designing and Implementing a TE-Constrained LDI Strategy

Pension Plan Volatility*

Asset allocation can have a substantial impact on funded status volatility.

*From 2002 to 2012 based on asset class monthly index returns.

Core fixed income: Barclays U.S. Aggregate Index Equities: 70% S&P 500 and 30% MSCI EAFE Index. Long government credit: Barclays U.S. Long Government/Credit Index. Long credit: Barclays U.S. Long Credit Index.

Sources: Barclays, Capital Group.

A well-designed LDI program with tracking error constraints can help plan sponsors strike a balance between expected excess return and risk controls.

Liability-driven investing has changed over the past decade. Defined benefit plan sponsors have gradually moved from broad mandates with considerable latitude to more tightly designed and benchmark-aware mandates. In recent years, some plans have taken this a step further and stipulated explicit tracking error constraints for LDI mandates. In our view, setting tracking error targets makes sense for pension plans that have substantially reduced plan risk, or the mismatch of assets and liabilities, also referred to as funded status volatility. In addition to tracking error targets, plan sponsors will benefit from also paying close attention to investment guidelines such as credit quality.

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August 2014
 |  FEATURING Robert W. Lovelace

The New Geography of Investing®: Morningstar® Interviews Rob Lovelace

On June 19, 2014, Janet Yang of Morningstar interviewed Rob Lovelace at the Morningstar Investment Conference on the subject of The New Geography of Investing.

Watch Video (6:50)

MSCI All Country World Index by Revenue and Domicile

The MSCI All Country World Index looks radically different when viewed through the revenue lens, particularly for the U.S. and emerging markets.

As of December 31, 2013. Source: MSCI.

Looking at companies’ and portfolios’ economic exposure, using revenues as a proxy, provides better information than country of domicile. For plan sponsors and other investors who build and analyze investment programs, measuring economic exposure should be part of a broader tool kit. It will help them better understand the opportunities and risks embedded in portfolios and build investment programs aligned with participants’ objectives.

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MSCI ACWI InfoTech Index by Revenues and Domicile

The U.S. represents a lower percentage of demand for technology products compared to the representation of the companies based in that country.

As of December 31, 2013. Source: MSCI.

The Technology Sector Through the Revenue Lens

The technology sector provides valuable information. As represented in the MSCI ACWI Information Technology Index, 73% of the market capitalization of technology companies is in the United States on the basis of domicile, but only about half of their revenues come from the U.S.

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INVESTMENT INSIGHTS  |  September 2013

Adding Value in TE-Constrained LDI Mandates

As plan sponsors gain experience with liability driven investing and approach a higher funded status, many are focused on designing and implementing LDI mandates with greater risk control. The imposition of tracking error targets on these strategies has been an important step in this direction. Tracking error constraints allow plan sponsors to gain visibility and better control over the discrete sources of risk and excess return in actively-managed LDI mandates.

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INVESTMENT INSIGHTS  |  April 2013  |  FEATURING Robert W. Lovelace

Investing by Economic Exposure: Implications for Investors

Over time, we have learned that country of domicile is a less effective way of measuring a portfolio’s exposure. Sometimes people ask me to explore establishing a fund invested in those U.S. companies that do business abroad. “Why take the risks of investing internationally when I can get, say, 40% exposure to non-U.S. revenues by investing in U.S.-based companies?” they ask. The straightforward answer, for one, would be that the decision-making and the outcome are not aligned.

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INVESTMENT INSIGHTS  |  April 2013  |  FEATURING William L. Robbins

Q&A With Will Robbins: Research Implications of a Globalized Economy

In an increasingly integrated global economy, many companies of all sizes are becoming global in their businesses. In this Q&A, Will Robbins, a research director and portfolio manager, discusses the ways in which Capital’s research groups are being organized and developed to meet the challenges of this evolving investment universe.

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INVESTMENT INSIGHTS  |  September 2012

New Pension Rules Shouldn’t Derail Long-Duration Strategies

Figure 1: Between 2004 and 2007, the 10-Year Treasury Yield Rose and the 25-Year Moving Average Fell

Source: Thomson Reuters Datastream
As of August 30, 2012

New federal pension rules that raise the discount rate applied to liabilities for contribution purposes have opened the debate on whether plan sponsors should delay implementation of asset-liability matching long-duration strategies. The new rules, which were included in the transportation bill that President Obama signed in July, may provide relief from the impact of the currently very low interest rates used to calculate liabilities for the purposes of determining minimum contributions under ERISA. Plan sponsors may be tempted to use this relief to reduce contributions and/or shorten duration in anticipation of higher interest rates. However, we believe that plan sponsors should think carefully before doing so, as relief from the law likely will be temporary and higher interest rates don’t necessarily undermine the long-term case for owning long-duration assets.

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Bond Management Can Add Value

Focus on bond management to maximize total returns

Source: Capital Group. For illustrative purposes only.

Implementing an effective long duration strategy has gained greater urgency for corporations as they begin to comply with the Pension Protection Act (PPA). The legislation, enacted in 2006, sets minimum funding standards for corporate defined benefit pension plans in the U.S.

Capital Group has managed a government/credit-plus long duration strategy for more than a decade. We recently introduced a new long duration strategy focused on credit partly to meet the need of clients who need a tighter match between assets and liabilities. The existing long duration government/credit strategy is wider in scope, investing in corporate bonds and government securities for greater flexibility, but with a looser match to liabilities. Both the credit and government/credit long duration strategies are also offered in “plus” variations, expanding the universe of investments to include global high-yield bonds. Capital’s long duration strategies focus primarily on cash fixed-income securities, using interest rate derivatives sparingly and primarily for yield curve management and duration positioning.

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Figures shown are past results and are not predictive of results in future periods. Current and future results may be lower or higher than those shown. Share prices and/or returns will vary, so investors may lose money. Investing for short periods makes losses more likely. View fund expense ratios and returns. 

Returns shown at net asset value (NAV) have all distributions reinvested. If a sales charge had been deducted, the results would have been lower.

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses or the collective investment trust's Characteristics statement, which can be obtained from a financial professional, Capital or your relationship manager, and should be read carefully before investing. 

You could lose money by investing in American Funds U.S. Government Money Market Fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other governmental agency, entity or person. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will do so at any time.

Investing outside the United States involves risks, such as currency fluctuations, periods of illiquidity and price volatility, as more fully described in the prospectus. These risks may be heightened in connection with investments in developing countries. Small-company stocks entail additional risks, and they can fluctuate in price more than larger company stocks. 

The return of principal for bond funds and for funds with significant underlying bond holdings is not guaranteed. Fund shares are subject to the same interest rate, inflation and credit risks associated with the underlying bond holdings. Lower rated bonds are subject to greater fluctuations in value and risk of loss of income and principal than higher rated bonds. Investments in mortgage-related securities involve additional risks, such as prepayment risk, as more fully described in the prospectus. While not directly correlated to changes in interest rates, the values of inflation-linked bonds generally fluctuate in response to changes in real interest rates and may experience greater losses than other debt securities with similar durations. 

Investment allocations for funds of funds may not achieve fund objectives. There are expenses associated with the underlying funds in addition to fund-of-funds expenses. The funds' risks are directly related to the risks of the underlying funds, as described herein. Each target date fund is composed of a mix of the American Funds and is subject to the risks and returns of the underlying funds. Underlying funds may be added or removed during the year. Although the target date funds are managed for investors on a projected retirement date time frame, the funds' allocation strategy does not guarantee that investors' retirement goals will be met. The target date is the year in which an investor is assumed to retire and begin taking withdrawals. American Funds investment professionals manage the target date fund's portfolio, moving it from a more growth-oriented strategy to a more income-oriented focus as the fund gets closer to its target date. Investment professionals continue to manage each fund for 30 years after it reaches its target date. 

State-specific tax-exempt funds are more susceptible to factors adversely affecting issuers of their states' tax-exempt securities than more widely diversified municipal bond funds. Income from municipal bonds may be subject to state or local income taxes and/or the federal alternative minimum tax (except for The Tax-Exempt Bond Fund of America). Certain other income, as well as capital gain distributions, may be taxable. 

Bond ratings, which typically range from AAA/Aaa (highest) to D (lowest), are assigned by credit rating agencies such as Standard & Poor's, Moody's and/or Fitch, as an indication of an issuer's creditworthiness.

Bond prices and a bond fund's share price will generally move in the opposite direction of interest rates.

Fund shares of U.S. Government Securities Fund are not guaranteed by the U.S. government.

Unlike mutual fund shares, investments in U.S. Treasuries are guaranteed by the U.S. government as to the payment of principal and interest. In addition, certificates of deposit (CDs) are FDIC-insured and, if held to maturity, offer a guaranteed return of principal.

There may have been periods when the fund(s) lagged the index(es). Certain market indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index. 

Investment results assume all distributions are reinvested and reflect applicable fees and expenses. 

Expense ratios are as of each fund's prospectus. 

The Capital Group companies manage equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed income investment professionals provide fixed income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity investment groups.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice. 

Regular investing does not ensure a profit or protect against loss. Investors should consider their willingness to keep investing when share prices are declining.

When quoting fund results to your clients, please refer to the American Funds quarterly statistical update, which includes results that reflect deduction of applicable sales charges. Please remember when sharing information on the American Funds with your clients that, in addition to providing current results and prospectuses, you should also discuss the risks and costs associated with the investment.

Past results are not predictive of results in future periods.