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| | Mutual Funds
American's funds stall as assets soar
At the huge mutual-fund family of American Funds, capital is pouring in even while the performance of some of the funds slips.
By Timothy Middleton
Success is beginning to spoil the giant mutual-fund family of American Funds.
This outstanding fund family attracted so many assets in the last two years -- $169.35 billion worth -- that the flows by themselves would have made it the sixth-largest fund complex in the nation.
As it is, American Funds is the second-largest, after Vanguard Group, according to Financial Research Corp. (FRC). It accounts for six of the 10 largest funds in the industry. But there are signs American Funds leadership is being overwhelmed by too many assets to manage.
It is the largest shareholder of a host of American corporations, including Altria Group (MO, news, msgs), AT&T (T, news, msgs), Lowes (LOW, news, msgs), Target (TGT, news, msgs), Fannie Mae (FNM, news, msgs) and BellSouth (BLS, news, msgs), making it essentially impossible to exit a damaged stock without suffering enormous damage itself.
American says it gets around the size issue by adding investment professionals at the rate of 8% a year, and by assigning only a portion of a funds assets to any one person. On the American Funds Growth Fund of America A (AGTHX), there are nine portfolio counselors, says Chuck Freadhoff, the firms spokesman, so no one individual is managing a particularly huge slice of the pie.
American has one of the best models for handling asset growth, says Russel Kinnel, director of fund analysis for Morningstar. The bad news is that even they have their limits. Its a little worrisome when you see this rate of growth.
Related news and commentary on MSN Money
Signs of slippage
The situation at American is far from acute; many of its funds remain in the top tier. But others, including individual funds that each hold more assets than most mutual-fund companies, have seen their performance slip as money has flooded in.
Its not hard to see why American has grown so large. It has little competition among broker-sold funds. In-house funds run by giant brokerage firms such as Merrill Lynch and Morgan Stanley tend to have poor records. Among independent broker-sold funds, some of the best known -- including Putnam Investments and MFS Investment Management -- were tarred in the mutual-fund scandals of 2003 and are still losing assets, according to FRC.
But its also not hard to see that, as American's funds have gotten bigger, some of them have faltered. When its American Funds Income Fund of America A (AMECX) had $24.56 billion of assets in 2003, it ranked among the top 14% of funds in Morningstars moderate-allocation category. Now, with $64.29 billion, it has tumbled to the 75th percentile.
Asset bloat at American has been nothing short of astonishing. Three years ago, Pimco Total Return A (PTTAX) was the largest mutual fund, with assets of $72.61 billion. Today it has grown 27.1% but has fallen to No. 3. American's Growth Fund of America A, which was fifth-largest then, has leap-frogged into the No. 1 spot with asset growth of 258%.
| American six of the 10 largest mutual funds | | Fund | Assets today | Assets 3 years ago | | American Funds Growth Fund of America A (AGTHX) | $136.75 billion | $38.20 billion | | Vanguard 500 Index (VFINX) | $109.42 billion | $66.82 billion | | Pimco Total Return A (PTTAX) | $92.23 billion | $72.61 billion | | American Funds Invest Co of Amer A (AIVSX) | $81.14 billion | $47.78 billion | | American Funds Euro Pacific Grade A (AEPGX) | $77.89 billion | $22.68 billion | | American Funds Washington Mutual A (AWSHX) | $77.83 billion | $44.24 billion | | Vanguard Total Stock Mkt Index (VTSMX) | $68.95 billion | $19.85 billion | | American Funds Income Fund of Amer A (AMECX) | $64.29 billion | $24.56 billion | | Fidelity Contrafund (FCNTX) | $63.83 billion | $26.82 billion | | American Funds Capital Inc Builder A (CAIBX) | $61.73 billion | $14.10 billion |
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Notes: As of 3/31/2006. Excludes money-market funds. Source: Morningstar.
Among giant stock funds, the only non-American fund that is actively managed, Fidelity Contrafund (FCNTX), is acknowledging the dangers of too much growth by closing to new investors at the end of this week. Fidelity closed Fidelity Magellan (FMAGX) years ago, but not before performance deteriorated. American has never closed a fund.
Big stakes
Size by itself is much less of a problem for index funds, which account for the other two giant equity funds. Pimco Total Return A, an actively managed bond fund, has continued to beat its benchmark, the Lehman Brothers U.S. Aggregate Bond Index, for nine of the last 10 years, the exception being 2002 when it trailed by 0.06%.
American Funds, managed by Capital Research & Management, gives about 75% of a funds assets to a large team of managers, generalists who are free to invest as they wish. The other quarter of assets are handed over to industry analysts to invest in their best ideas.
Freadhoff says Capital Research has about 150 portfolio managers and analysts, and that they are strong-willed and independent. Still, all the largest domestic-equity funds have a strong value bias, and managers are certainly drawn to many names in common. It owns huge positions, nearing 15%, in many large corporations.
It is the largest or second-largest shareholder in nine of its top 10 positions.
| American Funds top holdings | | Stock | Ownership | | Altria Group (MO, news, msgs) | 7.8%* | | Microsoft (MSFT, news, msgs) | 3.6%** | | General Electric (GE, news, msgs) | 2.4% | | AT&T (T, news, msgs) | 7.9%* | | Citigroup (C, news, msgs) | 3.3%** | | Lowes (LOW, news, msgs) | 14.9%* | | Target (TGT, news, msgs) | 14.2%* | | Fannie Mae (FNM, news, msgs) | 13.6%* | | Google (GOOG, news, msgs) | 5.6%** | | BellSouth (BLS, news, msgs) | 12.1%* |
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Notes: Reflects percentage ownership of corporation, not fund assets. * Largest shareholder. ** Second-largest shareholder. Sources: MSN Money, Morningstar.
Safe, but not the best choice
To paraphrase something that was said of IBM (IBM, news, msgs) in the 1960s, no broker ever got fired for recommending American Funds. Their expenses are among the lowest in the industry, even after taking sales commissions into account. Their management is squeaky clean. Many American funds are top performers.
The problem is, some are not, and indeed have experienced performance falloffs in recent years, as shown by the table below.
| Performance slows | | Funds by category rank | 3 years | 5 years | 10 years | | American Funds Growth Fund of America A (AGTHX) | 6 | 4 | 2 | | American Funds Invest Co of America A (AIVSX) | 76 | 48 | 16 | | American Funds Euro Pacific Grade A (AEPGX) | 14 | 9 | 4 | | American Funds Washington Mutual A (AWSHX) | 87 | 54 | 26 | | American Funds Income Fund of America A (AMECX) | 16 | 5 | 12 | | American Funds Capital Inc Builder A (CAIBX) | 44 | 29 | 23 |
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Notes: As of 3/31/2006. Scale = 1 is best, 100 worst. Source: Morningstar.
Most investment advisers shop for funds among the top 25% of their categories, in the belief they are most likely to sustain above-average performance. Three of Americans biggest funds meet this standard.
But three do not, and advisers ordinarily shun such laggards because they are most likely to continue to underperform. That has been true in spades of American Funds Invest Co of America A (AIVSX) and American Funds Washington Mutual A (AWSHX), yet investors have flooded them with $33.36 billion and $33.59 billion, respectively, in fresh assets in the last three years.
It's possible that brokers have been putting so many of their clients in these underperforming funds because commissions paid by investors go down as more assets are placed with a single company. Brokers have told me their own compliance officers have ordered them to choose funds within the same family for this reason, even though better alternatives exist with other fund companies.
But thats an issue of how brokers get paid, and it should be the furthest consideration from an investors mind. Some American Funds are great and some are not. Investors pay brokers so they dont have to make such choices themselves. They are being punished.
At the time of publication Timothy Middleton owned or controlled the following securities mentioned in this article: Vanguard Total Stock Market Index Fund.
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