Content provided by Case Eichenberger, CIMA, Client Portfolio Manager

CLS’s American Funds strategies have grown two-fold in the last year or so. That success brings on new advisors, clients, and relationships. As more new people use our strategies, we receive more due-diligence questions addressed to our portfolio management (PM) team.

One such question that has come up lately regards asset allocation and the funds we select. Optics, or how a portfolio appears, is very important to us when explaining to a client that this portfolio follows our themes, outlooks, and continuums. We can do this very easily with exchange traded funds (ETFs) as they have zero style drift and follow a very specific index. But with mutual funds, such as American Funds from Capital Group, it takes a little more strategy. American Funds’ PMs have a fair amount of flexibility and freedom. For example, the Growth Fund of America can take 25% of its portfolio and invest outside the U.S. This is why it is important to have a manager such as CLS to make sure these essential traits are tracked.

On to the question: CLS says it likes emerging market stocks and is overweight to this sector, but when my client pulls up his statement, he sees emerging markets allocated only 5%. When he has a 100 Risk Budget, how can that be?

The answer: Third party research providers, such as Morningstar, which CLS uses to classify funds, have a tough time fitting every mutual fund into a nine-box style grid. Looking at the New Economy fund, the flexibility of American Funds’ PMs allows them to go into emerging market stocks, even though Morningstar, for example, classifies the fund as “large growth.”

The below is a sneak peek at our process.

• Notice the total percentage stock of the portfolio is about 90% (top bold number). This is because mutual funds must hold some cash on hand for redemptions and other reasons, such as finding a good place to invest.
• Of that 90%, 18% is invested in emerging markets (EM) — a far cry from 5%!
• How does that work? Many of the funds invest in EM stocks, but not enough to be classified that way by research providers.
  • Take our example of New Economy, which fits in the large-cap growth style box. It has 21% of its stock invested in EM, which makes a material impact on performance.
  • Another good example is EuroPacific Growth. The name suggests it invests in Europe and Japan and is mostly a developed international fund with limited exposure to emerging markets. But, that is not true. This fund has 37% of its stock invested in EM companies along the Pacific, which is a big reason it has outperformed developed and total international stocks so far this year.

CLS keeps a close eye on where these funds go and how they play out in the total portfolio. We like EM and our American Funds strategies reflect that accordingly. The challenge comes when research providers place flexible funds, such as American, in a single bucket, which can make the optics look poor.

2637-CLS-6/7/2017