L.A.’s Capital Group accused of bilking employees — by pushing its own mutual funds
Los Angeles finance giant Capital Group manages dozens of mutual funds, all of them run by human beings who pick individual stocks and bonds to buy or sell.
And the vast majority of the assets of the company’s employee retirement savings plan is invested in those same funds.
Now, a former Capital Group worker is suing the firm, alleging it violated federal retirement savings rules by pushing workers into its own funds rather than offering investments from outside firms that charge lower fees.
Capital Group is the latest of several investment firms that have been targeted by lawsuits claiming that the companies push employees into actively managed mutual funds at a time when cheaper, passive funds that simply invest in the broader market are a better alternative.
Former employee D’Ann Patterson, in her lawsuit filed last week in Los Angeles federal court, alleges that Capital Group made “conflicted, disloyal, imprudent, and self-interested decisions” about what investments to offer, resulting in workers and retirees “paying excessive and prohibited fees that substantially diminished their retirement savings, and resulted in windfall profits for Capital Group and its subsidiaries.”
In a statement, the company said Patterson’s case was “without merit” and defended its fees.
“The funds offered to our associates are recognized in the industry as having among the lowest fees in their peer categories and superior investment results,” according to the statement.
The argument against Capital Group and the other firms being sued — including Franklin Templeton Investments, Putnam Investments and T. Rowe Price — is the latest development in an ongoing debate over the merits of actively managed funds at a time when passive funds are in vogue.
Pioneered by market leader Vanguard Group, passive index funds hold shares of all the stocks or bonds in a particular index — the S&P 500, for instance — and the performance of the fund tracks the performance of the index.
Such funds have a handful of benefits. For starters, they tend to be cheaper than actively managed funds, which must hire researchers and stock pickers to decide what to buy, hold or sell.
Index funds also have the implicit guarantee of doing just as well as the stock market overall. If the S&P 500 is up 10% for the year, an S&P 500 index fund will be up about 10%, too. Of course, if the index falls 10%, so will the fund.
Actively managed funds have the potential to perform better than the stock market as a whole — but most do not.
Over a 15-year period ending in December of last year, fewer than 8% of actively managed funds that invest in large public companies performed better than the S&P 500, according to a report from S&P Dow Jones Indices.
Investors have taken that kind of research to heart, pouring money into passive funds while withdrawing from active ones. In 2015 and 2016, active funds in the U.S. lost a combined $547 billion, while passive funds attracted $918 billion, according to data provider Morningstar.
Capital Group remains one of the world’s largest mutual fund companies, and its American Funds mutual funds have grown by about $370 billion since 2013 and now have nearly $1.5 trillion under management. But over that same period, Vanguard’s mutual fund assets grew from $2 trillion to $3.5 trillion.
The lawsuits against Capital Group, Franklin Templeton and other active fund managers highlight one key factor that has made the passive funds more popular — the lower fees associated with passive funds, specifically those offered by Vanguard.
Patterson’s suit, for instance, compares Capital Group’s Growth Fund of America, an active mutual fund that charges annual fees of 0.33% of assets, to a passive Vanguard fund that tracks the S&P 500 and charges annual fees of just 0.04%.
Growth Fund of America, though, outperformed the index fund over one-, three- and five-year periods, according to the lawsuit. Over the last five years, the Capital Group fund has averaged annual returns of 16.6%, compared with 15.4% for the Vanguard fund.
The lawsuit suggests that those figures do not include fees for either fund, but data from Morningstar suggests fees are included and that the Capital Group fund, higher fees and all, outperformed the Vanguard fund.
Patterson’s attorney did not respond to requests for comment.
Jerry Schlichter, a St. Louis attorney who has sued many big companies over alleged mismanagement of their employee retirement savings plans, said employers need an awfully good reason to steer retirement savings into active funds instead of generally cheaper passive funds.
“They have a significantly high burden to show their active funds will outperform passively managed ones,” said Schlichter, who is not involved in the Capital Group case. “And the literature says no one does that over time.”
Capital Group, though, believes it is an outlier.
Tim Armour, the company’s chairman and chief executive, told the Financial Times earlier this year that passive investing is “an important option,” but that Capital Group is “better than passive.” In a recent brochure, the company cited data from Morningstar to show that, even with fees, five of its mutual funds have outperformed a Vanguard S&P 500 index fund over the course of 40 years.
Duane Thompson, senior policy analyst at the investment consulting firm Fi360, said nearly two dozen similar cases have been filed against investment management firms. Few have been resolved, and some could take years to work their way through the courts.
Until cases get further along, he said, it’s difficult to say how the lawsuits against Capital Group and others will shake out. So far, though, he said no court has found that a company’s decision to offer active rather than passive investment options is a violation of the Employee Retirement Income Security Act of 1974, which regulates pension and 401(k) plans.
“There’s an ongoing debate within the investment community over which is better,” he said. “But I’m not sure a court is going to be eager to referee that fight.”
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UPDATES:
3:45 p.m.: This article was updated with performance figures for Growth Fund of America.
This article was originally published at 1:15 p.m.
