Capital International, Inc. Capital Group Investment Management Ltd ACN 164 174 501

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Long-Term Investing Not all fund managers can stand the test of time

November 2016

FOR PROFESSIONAL INVESTORS AND INFORMATION PURPOSES ONLY

1

Summary

• Fund managers merge or shut down funds for a mixture of reasons.

• Those with a low record of restructuring their funds tend to be more aligned with investors’ long-term objectives.

• Their funds are also more likely to produce stronger returns over the long run.

Ten years ago, nearly 5,400 US-domiciled mutual funds were available to investors. Today only around 36% of them are still in existence, according to Morningstar data. Put another way, the chances of long-term investors picking funds that are later merged or closed are fairly high.

The potential upside for investors when funds merge may include lower expenses and stronger funds. But there could also be tax implications when a fund closes. And if a fund is transferred

to another manager following a corporate merger, investors may be saddled with higher management fees. In some instances, the investment strategy or objective could change.

Being selective when investing in funds is therefore important. Our research proposes that fund managers with a low record of merging or closing their funds are more likely to be aligned with investors’ long-term objectives. Better yet, their funds could produce stronger returns over the long run.

Not all fund managers can stand the test of time.

2

Fund managers are not created equal

Fund managers merge or close funds for many reasons. There are those that combine similar products to build economies of scale. For some, though, the triggers are weak results and small asset bases. To determine the rate at which fund managers restructure their funds, we developed a new metric, the “obsolete ratio”, defined as a fund manager’s total number of merged and liquidated funds divided by the number of funds incepted.

Obsolete ratios are related yet distinct from the concept of “survivorship bias”. The former measures how often a fund manager merges or closes a fund, while the latter refers to the tendency for historical returns to be inflated because funds that perform poorly are often discontinued or merged.

Given that the US is the world’s largest investable market, holding 57% of total assets, we based our data on the entire Morningstar US-domiciled universe, focusing solely on actively managed funds. That amounted to around 13,000 funds within approximately 100 asset classes, and close to 1,250 fund managers.

Among the 20 largest active fund managers, eight have an obsolete ratio of less than 25%, while the highest is 68%. The median obsolete ratio, in

comparison, is around 42%. By this measure, Capital Group is the biggest active manager with one of the lowest obsolete ratios in the industry.

A fund manager’s obsolete ratio, in our view, can offer insights into the group’s investment philosophy and process. For one, low obsolete ratios imply that fund managers exercise greater prudence before introducing new products; rather than chase the latest investment fads, they are more likely to launch thoughtfully designed funds to meet investors’ needs.

Further, fund managers with low obsolete ratios are more likely to focus on long-term results and tend to have a robust investment process. After all, a fund manager sets the investment process and environment, which enables consistent and repeatable results.

Investors should find some comfort investing with such fund managers, knowing that they are less likely to restructure their funds, or create multiple products, only to close them when the fads have worn off. Deciding on a fund given the surfeit of choice, therefore, requires entrusting not only a portfolio management team but also a fund manager that is focused on investors’ long-term objectives and sticks by its products.

Obsolete ratio is defined as:

No. of merged funds + No. of liquidated funds

Total no. of funds

Fund managers with low obsolete ratios tend to exhibit stronger long-terms returns

US large-cap universeHaving determined the obsolete ratios for all fund managers, we sought to analyse the relationship between obsolete ratios and long-term returns. We started with the US large-cap universe, which represents the biggest investable universe, taking all the funds in that space and segmenting them into quartiles based on obsolete ratios.

So the first quartile comprises funds from managers with the lowest obsolete ratio, while those from managers that merge or liquidate their

funds most often were placed in the fourth quartile. We studied the funds’ average returns over rolling 5- and 10-year periods between 1996 and 2015, and examined the results relative to their peers and the Standard & Poor’s 500 Composite Index.

Our findings showed that the portfolio of funds in the first quartile recorded the highest average returns over rolling 5- and 10-year periods. As seen in the charts on the next page, fund managers in the first quartile recorded average returns of around 6% and 5%

A low obsolete ratio implies:

• Lower likelihood of restructuring funds

• More thoughtfully designed funds

• Greater focus on long-term results

• A more robust investment process

3

US large-cap funds from fund managers with the lowest obsolete ratios fared best They recorded the highest average returns and consistently outpaced their peers and the index (1996-2015)

Average returns % of rolling periods in which the quartile outpaces all other quartiles

% of rolling periods in which the quartile outpaces the index

Past results are not a guarantee of future results. Source: Capital Group. Funds include those from the Morningstar US large-cap universe. Groupings determined by each fund manager’s obsolete ratio. Average returns based on an equally weighted portfolio of funds in each quartile. Fund returns histories are of varying lengths, given the number of funds that were incepted, liquidated or merged. Index is S&P 500.

3.2%

4.3%

4.8%

5.4%

3.6%

4.7%

5.2%

5.9%

0 5 10(%)

Fourth quartile(highest obsolete

ratio)

Third quartile

Second quartile

First quartile(lowest obsolete

ratio)

Rolling 5-year periods Rolling 10-year periods

Fourth quartile(highest obsolete

ratio)

Third quartile

Second quartile

First quartile(lowest obsolete

ratio)

Rolling 5-year periods Rolling 10-year periods

0 20 40 60 80 100(%)

0.0%

20.7%

64.5%

40.5%

0.0%

18.8%

50.8%

66.3%

Fourth quartile(highest obsolete

ratio)

Third quartile

Second quartile

First quartile(lowest obsolete

ratio)

Rolling 5-year periods Rolling 10-year periods

0.0%

0.0%

2.5%

97.5%

0.0%

0.0%

13.8%

86.2%

0 20 40 60 80 100(%)

in rolling 5-year and 10-year periods respectively, compared with the more modest 4% and 3% average returns generated by managers in the fourth quartile.

Moreover, those in the top quartile outpaced their counterparts in the

other quartiles 86% of the time on a rolling 5-year basis, and an impressive 98% over rolling 10-year periods. By contrast, managers in the third and fourth quartiles always trailed their peers. The same trends were evident when assessing them against the S&P 500 Index.

The case for selectivity: Capital Group Investment Company of America strategy

Established in 1934, the Investment Company of America (ICA) strategy invests in seasoned companies primarily domiciled in the US that have a history of paying regular dividends. The portfolio managers are focused on the long term and that long view extends

to dividends too; they consider a company’s current dividend as well as the ability of that company to grow its dividend over time. As past results have shown, the longer the ICA strategy has been held, the more robust the returns.

Capital Group Investment Company of America CompositeThe value of US$100 invested in the Capital Group Investment Company America Composite

Past results are not a guarantee of future results. Data as at 30 September 2016. 1. The results shown for the Capital Group Investment Company of America Composite are asset-weighted and based on

initial weights and monthly results, shown in US$ terms, and gross of management fees. Source: Capital Group2. The benchmark shown is the S&P 500 Total Return Index. Source: S&P

“Not only has this fund been around a long time, but it also benefits from highly seasoned management. …it has beaten the S&P 500 in more than 70% of rolling 10-year periods, while besting the category average in 100% of rolling 10-year periods.”

Morningstar, 17 August 2016

Lifetime annualised returns (%)

After fees

Investment Company of America composite

11.0

The composite results shown above are asset-weighted and based on initial weights and monthly results, shown in US$ terms. Fees applied are net of the highest fees of 1.75%.

10

1001,000

10,000100,000

1,000,00010,000,000 (Rebased to 100)

Dec 33 Dec 53 Dec 73 Dec 93 Sep 16

S&P 5002 | US$461,000 | 10.7% p.a.

ICA1 | US$2,346,000 | 12.9% p.a.

4

Global equity universe

We applied the same screens to global equity funds to test our hypothesis that fund managers with lower obsolete ratios tended to be more resilient than those with higher obsolete ratios. The universe, comprising around 450 funds, is much smaller than the more than 2,000 funds in the US large-cap universe.

We came to the same conclusions. Fund managers with lower obsolete ratios produced consistently better

average returns on rolling 5-year and 10-year bases. Those in the first quartile outpaced their peers 93% of the time over a rolling 5-year period, as seen in the chart below.

On a rolling 10-year basis, they beat the other quartiles and the MSCI All Country World Index 100% of the time – in short, they invariably outpaced their peers as well as the index.

Global equity funds in the first quartile tended to produce consistently higher returnsThey outpaced their peers 93% of the time on a rolling 5-year basis (1996-2015)

-4.0

-2.0

0.0

2.0

4.0

6.0 (%)

Dec-00 Dec-03 Dec-06 Dec-09 Dec-12 Dec-15

First quartile (lowest obsolete ratio) Second quartile Third quartile Fourth quartile (highest obsolete ratio)

Past results are not a guarantee of future results. Source: Capital Group. Funds include those from the Morningstar world stock universe. Groupings determined by each fund manager’s obsolete ratio. Average returns based on an equally weighted portfolio of funds in each quartile. Fund returns histories are of varying lengths, given the number of funds that were incepted, liquidated or merged. Index is MSCI All Country World Index.

The case for selectivity: Capital Group New Perspective strategy

The New Perspective strategy, in its pursuit of global growth, looks at a company’s geographic revenue stream, rather than just its country of domicile. This approach has provided for a greater understanding

of investment opportunities and risks in this rapidly evolving world and helped it weather many different market conditions, protecting on the downside 100% of the time in rolling three-year down markets.1,2

Capital Group New Perspective CompositeThe power of compounding excess returns

Annualised growth, in % terms, since launch

Past results are not a guarantee of future results. Data as at 30 September 2016.1. Results shown for the Capital Group New Perspective Composite, from inception at 31 March 1973, are asset-weighted

and based on initial weights and monthly returns, shown in US$ terms, and are gross of management fees. Source: Capital Group

2. MSCI ACWI (net dividends reinvested) from 30 September 2011; previously MSCI World (net dividends reinvested).

“Since its 1973 inception…, it has trounced its typical category rival and the MSCI All-Country World Index; the results are similar if you compare the fund with its former benchmark, the MSCI World Index. The fund has amassed this record without incurring more volatility than its average peer or index.”

Morningstar, 1 July 2016

13.0%

8.3%

Capital Group New Perspective Composite1

MSCI ACWI²

4.7% higher than the market return

Lifetime annualised returns (%)

After fees

New Perspective composite 11.1

The composite results shown above are asset-weighted and based on initial weights and monthly results, shown in US$ terms. Fees applied are net of the highest fees of 1.75%.

5

Emerging market universe

Finally, we extended our research to the emerging market universe. The findings here are more ambiguous for several reasons: highly volatile returns, a relatively young asset class (just 50 funds two decades ago), and a far smaller universe of around 300 funds. There has also been many changes, with new funds being created and merged or shut down as the market develops.

Although the universe is less diversified, on balance, fund managers in the first

quartile continue to do better than those in the fourth quartile on rolling 3-, 5- and 10-year periods, as the charts below illustrate.

For example, over a rolling 5-year period, fund managers that were least likely to restructure their funds outpaced the MSCI Emerging Markets Index over 50% of the time. By contrast, fund managers that most frequently merged or liquidated their funds fared better than the index only 17% of the time.

Emerging market equity funds in the first quartile fared better than those in the fourth quartileThey outpaced the index over 50% of the time on rolling 3- and 5-year bases (1996-2015)

% of rolling periods in which the quartile outpaces the index

Past results are not a guarantee of future results. Source: Capital Group. Funds include those from the Morningstar emerging market equity universe. Groupings determined by each fund manager’s obsolete ratio. Average returns based on an equally weighted portfolio of funds in each quartile. Fund returns histories are of varying lengths, given the number of funds that were incepted, liquidated or merged. Index is MSCI Emerging Markets Index.

51.9%54.2%

39.7%

27.3%17.1% 16.5%

0%10%20%30%40%50%60%

Rolling 3-year periods Rolling 5-year periods Rolling 10-year periods

First quartile (lowest obsolete ratio) Fourth quartile (highest obsolete ratio)

The case for selectivity: Capital Group New World strategy

The New World strategy focuses on growth in developing economies from a multidimensional, global perspective – combining local emerging market businesses along with global multinationals

that have significant exposure to developing economies. The portfolio managers believe this offers investors a more resilient way to capture the long-term potential of emerging markets.

Capital Group New World strategyReturn vs. volatility for the lifetime of the strategy

Past results are not a guarantee of future results. Data as at 30 September 2016.1. The results shown are for the Capital Group New World Composite gross of management fees, from inception at

30 June 1999 . The composite is asset-weighted based on initial weights and monthly returns, shown in US$ terms. Source: Capital Group

2. MSCI All Country World Index (ACWI) with net dividends reinvested. Prior to 31 December 2000, MSCI All Country World Index with gross dividends reinvested. Source: MSCI. MSCI Emerging Markets Index with net dividends reinvested. Prior to 31 December 2000, MSCI Emerging Markets Index with gross dividends reinvested. Source: MSCI

“New World often looks best when emerging markets are at their worst. The fund’s relatively conservative portfolio is prone to lag in rallies, but it has outperformed over the long haul by losing less in downturns. …What’s particularly impressive is that the fund has been less volatile than many developed-markets funds.”

Morningstar, 26 May 2016

New World1

Annualised return (%)

Annualised volatility (%)MSCI ACWI2

MSCI EM2

3.0

5.0

7.0

9.0

11.0

14 1816 20 22 24Lifetime annualised returns (%)

After fees

New World composite 6.9

The composite results shown above are asset-weighted and based on initial weights and monthly results, shown in US$ terms. Fees applied are net of the highest fees of 1.75%.

Statements quoted from Morningstar are based on the respective US-registered mutual funds.

Composite information shown in this document supplements or enhances required or recommended disclosure and presentation provisions of the GIPS® standards, which if not included herein, are available upon request. GIPS is a trademark owned by CFA Institute.

This communication is strictly for the confidential use of the recipient, solely for the purpose for which it is provided, and may not be disclosed or circulated to, or relied upon by third parties. Past results are not a guarantee of future results.This information is neither an offer nor a solicitation to buy or sell any securities or to provide any investment service. Statements attributed to an individual represent the opinions of that individual as of the date published and may not necessarily reflect the view of Capital Group or its affiliates. While Capital Group uses reasonable efforts to obtain information from sources which it believes to be reliable, Capital Group makes no representation or warranty as to the accuracy, reliability or completeness of the information. The information provided in this communication is of a general nature and does not take into account your objectives, financial situation or needs. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs.This communication has been prepared by Capital International, Inc., a member of Capital Group, a company incorporated in California, United States of America. The liability of members is limited.In Australia, this communication is issued by Capital Group Investment Management Limited (ACN 164 174 501 AFSL No. 443 118), a member of Capital Group, located at Level 18, 56 Pitt Street, Sydney NSW 2000 Australia.All Capital Group trademarks are owned by The Capital Group Companies, Inc. or an affiliated company in the US, Australia and other countries. All other company and product names mentioned are the trademarks or registered trademarks of their respective companies. © 2016 Capital Group. All rights reserved. CR-296482 ASIA

Conclusion

Long-term investors ought to give serious consideration to fund managers when deciding on the funds to invest in. For one thing, fund managers with a low record of merging or closing their funds tend to be more aligned with investors’ long-term objectives.

And although past results are not predictive of results in future periods, our research suggests that their funds tend to produce more robust returns over the long run. As investors sift through information about the many funds on offer, fund managers would be a good place to start.