My Favorite Rejects

This article originally appeared in Morningstar FundInvestor, an award-winning newsletter that presents investment strategies and tracks 500 funds.

It's amazing what people will throw out.

I took a look at a list of the 20 funds with the largest net outflows in dollar terms for the year to date through July 31 and found a number of good funds. (Note: Our flow estimates are based on returns and monthly asset figures--not official flow reports from the fund company.) Sure, some are dogs or simply mediocre, but others are good funds that are just out of favor. In fact, I welcome the outflows because some of these big funds could stand to be more nimble.

Vanguard 500 Index VFINX
Can you believe this is number four on the list? Me neither. This fund has suffered net redemptions of more than $3 billion in 2006. No doubt the reason is that it is heavily weighted in mega-cap stocks, which have lagged the rest of the world for about six years now. But when those trends reverse, this fund will be a winner, particularly on an aftertax basis.

The fund has super-low costs, and I'm sure that over the next five or 10 years, it will beat a majority of large-blend funds, just as you'd expect of a good index fund. Not exciting, but effective.

Fidelity Growth & Income FGRIX
This fund has been pretty dull in recent years, but to me, its prospects haven't looked this good in a long time. The fund's outflows of $2.2 billion take assets down to a more manageable $29 billion--still huge, but not too bad for a blue-chip fund. Also, Tim Cohen, who took over last October, has a strong track record at Fidelity Export & Multinationals FEXPX. To be sure, the fund has been a dud during his short stint, but I wouldn't read too much into 10 months. Cohen is an eclectic manager who will buy all manner of companies provided that they look cheap to him. He may well hit his stride now that he's completed his portfolio overhaul.

American Funds Washington Mutual AWSHX
Most American funds are too big, but this isn't  the one to sell. The fund's conservative mandate requires it to buy only companies that have paid dividends in nine of the past 10 years. It has suffered about $4 billion in outflows because its dividend discipline limits it mostly to conservative, large-cap stocks. The mega-caps have lagged lately, so the fund has been unimpressive, but it continues to do just fine compared with its investment universe. Interestingly, it has also been hurt by the fact that its ban on tobacco companies has kept it out of strong-performing Altria Group MO (the company formerly know as Philip Morris).

Moreover, this is a fund you want for defense, not offense. It held up splendidly during the last market sell-off and may do so again. Because its universe us already limited to big stocks and the fund has a low turnover, it's less susceptible to asset bloat than most American funds. And while you wait, you get a nice yield of tax-advantaged dividend income.

Vanguard GNMA VFIIX
With $1.2 billion in net outflows, this fund is number 20 on the list, so the rate of redemptions isn't very dramatic. Even so, it's surprising that someone would sell a fund that hasn't lagged its peer group in a single calendar year since 1998. Sure, in absolute terms, the fun's year-to-date return of just 1.7% is hardly exciting, but that's still better than 80% of intermediate-term government funds. Here, you get all the things you'd expect from a Vanguard bond fund: low costs, a sound strategy, and good management. When bonds rally, watch for the flows to come pouring back in.