No Longer Chasing The Lead Horse

Back before the Internet bubble burst, mutual fund investors didn't just chase performance, they galloped after it. Among the 10 best-selling funds of 1999 were Fidelity Aggressive Growth Fund (FDEGX ), which gained 103% that year, and Janus Twenty Fund (JAVLX ), up 65%, as the Standard & Poor's 500-stock index climbed a none-too-shabby 20%. Longer-term results weren't as pretty. The three-year bear market was particularly unforgiving to such former highfliers, whose shares lost 77% and 64% of their total value, respectively, from 2000 through 2002.

Maybe investors have learned their lesson. The funds getting the big bucks in 2006 are not those with the biggest returns. Instead, Capital Research & Management's American Funds dominate, holding the No. 1, 2, 3, and 10 spots. Characterized by steady performance and lower-than-average fees, those four team-managed funds alone pulled in more than $25 billion in new cash in the first four months of the year. Best-seller Growth Fund of America (AGTHX ) typically ranked among the 20% of top-performing similar funds in any one of the past five years, never quite topping the charts. But consistency has helped put its five-year combined record in the top 5%.

The leadership of Los Angeles-based American Funds does raise a new concern, though, about whether ballooning fund assets will hurt future performance. American has been the top-selling fund firm in each of the last four years. Its managers outperformed most others in the bear market and continued to do well once the market turned up. After years at the top of the charts, Growth Fund of America had grown to $146 billion by the end of April, and EuroPacific (AEPGX ) Fund had swelled to $87 billion. "Their shareholders are all participants in a massive, ongoing experiment: How large can any fund company get without hurting investment performance?" says fund watcher Roy Weitz, who runs the Web site

The bear market also taught investors about the value of diversification. While 1999's list included just one international fund, half of today's top 10 sellers invest globally. International markets usually don't move in tandem with the U.S., so adding a dollop of overseas funds can temper portfolio volatility while improving returns. More investors are opting for less risky funds that spread their bets over an array of stocks and countries. The best-sellers of 2006 "seem to be more diversified portfolios, unlike the Janus Twenty, which was focused on too few stocks," says Paul Irvine, a finance professor at the University of Georgia's Terry College of Business, who has studied funds. "Plus, most investors do not have the international exposure they should."

Index funds seem to have lost some ground in the top 10 this year, with just two such funds, vs. three in 1999. That might dismay those who advocate low-cost market matching. It seems investors are chasing performance after all: Most actively managed funds beat indexers last year.

By Aaron Pressman

    Before it's here, it's on the Bloomberg Terminal.