Annual Report - American Balanced Fund - American Funds

A closer look at thefixed-income portfolioInside the research portfolio:In 2008, there were few safe harbors forinvestors. In the fixed-income market,many were surprised at the volatilityof high-grade corporate bonds. OnlyTreasuries did well.“Since then, the fixed-income markethas become even more complex,” saysPortfolio Manager John Smet. “Moreinstruments are available and the numberof players, including non-U.S. investors,has grown dramatically.”To effectively cover this market, AMBAL hasfive fixed-income portfolio managers. JohnSmet, Jim Mulally and Hilda Applbaumare generalists who buy U.S. Treasurybonds, investment-grade bonds issuedby governments and corporations, andsecurities backed by home mortgages fromFannie Mae, Freddie Mac and Ginnie Mae.Wesley Phoa and Andy Barth together actas a fourth generalist manager; Wesleyfocuses on Treasuries, governmentagencies and mortgages, while Andyspecializes in credit securities, which areprimarily investment-grade corporatebonds (rated BBB/Baa and above).“One of the main things we all try toremember is that fixed income is meantto be a part of AMBAL that is stable andgenerates income. It’s an importantpart of the balance for our investors,”describes Wesley.Research is a critical component oftheir efforts. Andy explains, “I think ourinvestors are fully aware of the strongresearch capability that Capital bringson the equity side. We’re doing that verysame thing in fixed income as well inorder to make informed decisions.”As part of that initiative, two groupswere introduced, post-2008, to betterleverage the power of The CapitalSystem of investing:Portfolio Strategy Group (PSG):“The PSG is a part of The CapitalSystem that’s unique to fixed income,”explains Jim. “It provides disciplineto the portfolio through top-downguidance, which helps us make moreconsistent investment decisions.”Specifically, the PSG establishesbroad, strategic parameters that actas a guide in the construction ofAMBAL’s fixed-income portfolio. It isthen up to the portfolio managers touse their own creativity within thoseguidelines. The overall goal of thePSG is to promote good investmentresults over full market cycles.Risk and Quantitative Solutions Group(RQS): This team of risk analysts areintegrated into Capital Group’s fixedincomeorganization to contributeto superior long-term investmentresults through rigorous disciplineand quantitative analysis based oncomputer modeling. A “virtual”portfolio of the fund’s holdings issubjected to a variety of simulationsdesigned to mirror the effects ofpotential economic scenarios andmarket movements over time. “Futurerisk is a big challenge for anyone inthe fixed-income market,” says John.“The simulation work done by RQS isan effective way to understand the riskin our portfolios.”Justin TonerSectorsU.S. Aerospace and defenseU.S. and Japanese automobilesWaste services (environmental services)Beyond coordinating the overall researchportfolio, Justin invests in three equitiesin AMBAL, including Lockheed Martin,one of the fund’s top industrial holdings.“This has been a large investment forus for many years, and we invested a lotmore in it fairly recently,” says Justin.“Lockheed Martin is an extremely wellmanaged,cash-generative company.And management returns that cash toshareholders through dividends andshare re-purchases.“It was an extremely cheap equity inearly 2013, when it looked like defensespending was going to be hit hard inWashington. But it’s often when sentimentis most negative that you have theopportunity to invest in a good companyat a great price. Even now, as it appearsdefense spending may rise again, albeitmodestly, the company remainsa reasonably valued investment.”10 American Balanced Fund