Fund in Focus: American Funds EuroPacific Growth Fund
American Funds EuroPacific Growth Fund stands out as one of the first and largest funds in the foreign equity category. The fund’s size and asset growth have not impeded its process and performance, and the fund has remained open to new investors. Its malleability is owed to the fund’s multi-manager structure, as each of the nine portfolio managers has run separate sleeves of the portfolio in line with their investment style and process. This combination has provided a smoother ride for investors, allowing the strategy to take on different tilts to help the fund perform well in different market environments.
The fund primarily invests in the equity of non-U.S. companies based in Europe and the Pacific basin. Although the fund tends to mirror its benchmark in terms of allocations to individual countries, it differs on stock selection within each country. Since the fund’s inception in April 1984, it has had style drifts from the foreign large-blend to foreign large-growth categories of Morningstar classification. The fund also changed benchmarks in 2007 from MSCI EAFE ex-US to MSCI ACWI ex-US to reflect its growing exposure to emerging markets equity. Despite these changes, the fund’s fundamental bottom-up stock selection process has remained intact. Its investment philosophy is focused on the growth of capital over the long-term investment horizon, which has kept the portfolio’s turnover low and costs in check. The fund’s expense ratio is one of the lowest among actively-managed funds in its category.
To manage the volatility of international equity markets, the fund limits its stock-specific risk and stays diversified with 290 stocks in its portfolio. Compared to its peers, the fund has larger exposure to emerging markets equity positions in countries such as China, South Korea, and India. Due to the fund’s increasing asset base and low-growth environment in developed countries, the fund’s emerging markets exposure has increased to approximately 26% of its total assets. The fund’s top holdings are in tech companies such as Alibaba, Nintendo, and Tencent, and pharmaceuticals companies such as Novo Nordisk.
Since the financial crisis, the fund’s higher exposure to sectors such as healthcare and technology have helped it to remain competitive as growth stocks outperformed its value counterparts. As the demand for healthcare has grown with the world’s aging population, the fund managers have capitalized on this trend by investing in healthcare companies, especially pharmaceuticals. The fund also benefited from the growing number of consumers in developing markets, as a significant number of its investments derive revenue from these markets. While only one quarter of the fund’s assets are invested in companies that are domiciled in emerging markets, 45% of the total revenue comes from emerging markets investments.
Despite having higher emerging markets-based revenue, the fund’s risk has remained muted, with risk indicators such as standard deviation staying quite low. The fund also provided better downside protection for investors as it performed relatively well in bear markets such as 2001-2002 and 2008, outperforming its benchmark. The outperformance in 2008 is partly attributed to the higher allocation of cash in the fund’s portfolio and its lower financials sector position. Cash is typically 6%-10% of the fund’s assets, but can rise to as high as 15% during periods of market stress, or when the managers cannot find good values. Higher cash position can be a good cushion in down markets, but can also drag performance in market rallies. Increasing asset size can result in higher cash positions if managers’ investment opportunities are diminished. The fund can also hold fixed income securities to lower the risk. The fund currently holds 9.1% in cash and cash equivalents.
The fund has approximately $132 billion in assets under management, a size at which other funds may face capacity issues. But with the multi-manager approach of American Funds, the strategy can add new portfolio managers to run additional sleeves for its growing asset base. However, adding additional managers means adding more stocks to the portfolio. By increasing the number of stocks in its portfolio, the fund must also include similar investments as a benchmark, causing the fund to become more benchmark-orientated and deviating from true active management.
The fund’s nine portfolio managers have a median tenure of 23 years. The portfolio managers are all personally invested in the strategy, and their compensation is tied to rolling performance results, with the highest emphasis on 5- and 8-year periods. A multi-manager approach, with each portfolio sleeve managed independently, allows the managers to apply their own philosophy. Thus, the fund composition ranges from concentrated growth to value-oriented strategies. The benefit of the fund’s approach is the diversity of opinions that help the fund adapt to different market environments. However, as there is no consensus of opinion, new portfolio managers could potentially tilt the portfolio in unexpected ways. For example, the departure of a more value-leaning manager in 2013 caused the fund to drift into the foreign large growth category in 2014.
As with most of the international equity funds, the fund does not hedge any currency exposure. Its portfolio managers believe that over the long term all currencies approach fair value, and therefore make hedging unnecessary. However, for U.S.-based investors, it can mean that currency movements, such as a strong dollar over a prolonged period, can dampen returns on an absolute basis.
The fund has an excellent track record with strong risk-adjusted returns, low fees, and less volatility than the index and its typical peer. With a consistent process and strong management, the fund has delivered positive value-add over the 3-, 5-, 10-, and 15-year periods. In its history, the fund has weathered several overseas financial market storms while delivering superior long-term results. Since its inception in 1984, the fund has returned 11.01%, as compared to its benchmark MSCI ACWI ex-US Index, with 8.69% during the same period.
Data Source: Morningstar, Capital Group; as of 03/31/2017
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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