American Funds has long been considered the mutual fund darling of the financial advisor world, topping lists of advisor fund favorites. In the decades since it launched its first mutual fund in the early 1930s, the fund group, part of The Capital Group of Companies, attracted quite a following. By April 2007, American Funds announced that its assets had surpassed the $1 trillion mark.

The ardor was well-earned. American Funds' performance was steady and reliable for decades. When the technology bubble burst in the early 2000s, for example, American Funds recorded some remarkable returns, weathering the storm while others sank. Indeed, it continued to capture investors and assets, even as other big players, such as Putnam Investments, Janus Capital and Alliance Fund Distributors, turned in weak performance and got caught up in the market-timing and late-trading scandals that then dominated the news. Indeed, in 2002, American raked in $38 billion in assets, representing 28 percent of the industry's total asset inflows, says Financial Research Corp. in Boston.

But in the past year, the mutual fund giant's fortunes seem to have turned, with sizeable outflows of about $49.5 billion in assets in the 12 months ending Dec. 31, according to Morningstar data. (See table, page 28.) As of Dec. 31, the company held about $957 billion in assets, according to Morningstar, pulling it back below that $1 trillion mark.

Granted, last year was a horrible year for equity funds industrywide. Retail investors rushed to dump equities and poured money into the bond market, and in that context, American's asset outflow is not unique. In 2010, $75.8 billion left U.S. equity funds, while about $216 billion flowed to taxable bond funds, according to Morningstar.

Still, American Funds had a special place in advisors' hearts and, in that context, the outflows seem surprising. After all, it was once a fund company that could seemingly do no wrong. And its expense ratios, which average 0.73 percent, according to Lipper estimates, are considered very fair given the funds' overall long-term performance.

So what went awry? Financial advisors complain that the funds did not live up to their reputation, performance-wise, in the last downturn. Some say the company's funds have simply gotten too big to deliver superior performance. Still other FAs are disappointed with American's wholesaler approach, which is less accomodating than that of other fund companies. And that's just a harder sell when you don't have the performance to back it up. Has the mutual fund giant become a victim of its own success?

Perhaps. American Funds spokesman Chuck Freadhoff says advisors began to think the fund group was invincible following its good fortune in the early 2000s, when everyone else was falling apart. They began to expect the funds would never go down, he says. “That perception was incorrect.”

One “Bad” Year?

Performance has certainly been lackluster in a number of American's funds of late, particularly its biggest. The group's top five funds in terms of assets underperformed their respective benchmarks in 2010, according to Lipper estimates. Its largest fund, the Growth Fund of America, was down 2.78 percent versus the S&P 500 last year. (See table on page 30 for outflow data.)

But some observers say that kind of short-term hiccup in performance is nothing to worry about. “Some of the American Funds have gotten huge, and there is reason to be concerned about that. But so far I don't see that the performance of American Funds is disappointing,” says Rep.'s long-time mutual funds editor, Stan Luxenberg. “Although academics say that it is impossible to pick good actively-managed funds, most American Funds have extremely strong long-term records.” A number of its funds have beaten their benchmarks by wide margins over the last 10 years, he says, including EuroPacific Growth, Growth Fund of America, and Investment Company of America. And while some American funds lagged in the past year, that is to be expected, he says, because American's funds tend to hold high-quality large stocks. Last year, investors preferred low-quality small stocks. “If blue chips ever lead again, American Funds will look smart.”

In fact, now might be a perfect time to buy American's funds, says Luxenberg, pointing to Morningstar's “Buy the Unloved Fund” strategy. According to this concept, funds that have performed well over the years but are currently out of favor, such as those offered by American Funds, are typically a good buy, and outperform when their strategies return to favor. Consider that over the last 10 years, American Funds had eight funds in the top quartile of their asset classes, with three funds in the top quartile over the last five years.

Kevin McDevitt, mutual fund analyst at Morningstar, says that from an investment standpoint, the outflows are not really about American Funds; he agrees that performance was not so bad in 2010. However, the funds could have been sold in such a way that advisors' and clients' expectations of how they would perform were out of whack, he speculates. While it's an industry credo never to sell on absolute performance alone, the reality is, that's what advisors — and clients frazzled by a topsy-turvy market — want to know about first. (The more enlightened advisor tends to look at risk-adjusted performance.)

Advisor Gripes

Indeed, some advisors say their expectations for American simply were not met. “Their performance didn't hold up,” says Harold Nahigian, a regional director with Financial Network and a big supporter of American Funds. The last couple of years, funds that were touted by the company have not performed as well as he hoped, he says. For example, the Capital Income Builder Fund (CAIBX) returned 8.66 percent in 2010, while the S&P 500 was up 15.06 percent, according to Lipper. And yet, for the three years ending Dec. 31, 2010, the fund met the benchmark.

The problem: FAs — or at least their clients — want to see gains, year in, year out. “Many investors want to see rocket-like performance” all the time, says Jeff Tjornehoj, head of research at Lipper.

And then there is the matter of wholesaler support. American Funds' wholesalers are perceived as having an “elitist attitude” and “cushy lifestyle,” says Magnus Brandfors, an independent advisor in the Pacific Northwest. Some advisors say they act as if they don't need their business.

“Unless you're giving them enormous amounts of business every year, you won't get much attention from them,” Brandfors says.

In fact, a sort of standoffish attitude seems to permeate the corporate culture. American Funds doesn't advertise, and it doesn't go direct to retail investors either. The company has also tried to avoid journalists, preferring to stay out of the media spotlight.

While other fund companies tend to explain how their funds would complement funds from other families within a portfolio, American Funds' wholesalers will only talk about their own funds, says a Wells Fargo advisor. He also found that American Funds would only support an event or make a presentation if the company wholesaler could also tout American Funds. Other fund companies tend to give generic presentations on the state of the economy that are not self-promotional. “They just tend to be more difficult to work with,” he says of American.

These are merely anecdotal reports, of course. Not everyone is unhappy, and American is committed to financial advisors, who continue to recommend American Funds, says Freadhoff. “We remain 100 percent committed to the advice model and to the individual advisor. We do the best job we can in helping our advisors represent American Funds to their clients.”

Meanwhile, the American brand remains strong among FAs, according to some reports. In a recent benchmarking survey from kasina and Horsesmouth's FA Vision service, American Funds received the highest score in the FA Vision Brand Index, which represents a firm's perceptions among financial intermediaries. To those surveyed, American Funds was the most consistent, dedicated to advisors, ethical and trustworthy.

Meta Trends

Perhaps the reasons for American Funds' change of fortune have less to do with the fund company and more to do with a couple of major market trends, some of which were caused or accelerated by the financial crisis, says Avi Nachmany, director of research at Strategic Insight. He ticks off a growing bias against active management; an increased demand for bond funds, particularly short-duration bonds; the lingering risk-aversion pushing investors away from stock funds; diversification away from U.S.-focused stock funds toward global stocks funds; and the growing appeal of investment solutions such as packaged asset allocation, tactical asset allocation and funds of funds.

For example, assets in ETFs (passive investments, mostly) have been growing by an average 54 percent a year since 1993, according to Bernstein Research. And American Funds has more actively-managed stock funds than any other fund company in the U.S., with total assets in its actively-managed equity funds equal to those of Fidelity and Vanguard combined.

While the market trends Nachmany mentions have impacted all fund companies, they could impact American disproportionately simply because of its size, he says. “This is a trillion dollar company. When you are very large, you have larger numbers flowing out,” he says. When you look at the company's outflows as a percentage of total assets, redemptions were 5.2 percent last year. Other firms had similar outflows (See table).

But the firm may be trying to tweak its investment focus to address some of the issues Nachmany mentions. On Nov. 15, American filed with the SEC to launch a new Global Balanced Fund, which will include a balance of stocks and bonds across countries, including the U.S. The fund company also rolled out a Mortgage Fund and Tax Exempt Fund of New York in December, which are more bond-focused.

Some advisors aren't buying it. Says one Wells Fargo advisor, “I think they've already proven that they're not good at bonds.” In 2010, its Bond Fund of America outperformed its benchmark, the Barclays Capital U.S. Aggregate Bond Index, by 0.76 percent, according to Lipper. But when you look at the fund's three-year and five-year returns ending Dec. 31, 2010, it underperformed the benchmark by 10.58 percent and 14.13 percent, respectively.

In fact, American's existing Capital Income Builder Fund is similar to the new Global Balanced Fund but with a broader mandate, says Morningstar's McDevitt. It's hard not to notice that such world allocation funds are becoming very popular, he adds. If there's any common theme to the changes, he says, it's that American is getting more global, as investors look to get more global exposure.

Oversold?

So is this a simple case of overselling? Is the disappointment among advisors with American Funds' returns overblown? Luxenberg thinks so. “This is a time to buy American Funds and other funds that emphasize blue chips. Stocks that once commanded a premium over the market multiple now trade for a discount,” Luxenberg says. After a decade of favoring small caps, large stocks will eventually shift back into the lead, he predicts. Indeed, time and again, investors have dumped out-of-favor categories at the wrong time. One of the most dramatic cases of poor timing occurred in the late 1990s when investors bought Janus 20 and other large growth funds that emphasized expensive technology stocks, he says. Investors avoided noted value managers, including Robert Rodriguez of FPA Capital and Bill Nygren of Oakmark Select. Despite pleas from shareholders, those managers stuck to their discipline and avoided expensive stocks. “The caution paid off during the downturn of 2000,” he says. “More recently, investors have been dumping stock funds and buying bonds. That has been the wrong move. Since the market hit bottom in 2009, stocks have outperformed bonds by a wide margin.” If you're thinking about dumping that American fund, think twice.