Five Popular Mutual Funds That Must Shape Up or Ship Out

In the grand scheme of portfolio management, there are plenty of questions. What asset allocation will get me to my financial goals? How much risk can I tolerate? Which mutual funds should I buy?

But of all the questions, particularly those related to mutual funds, one stands out as being especially tough: When is it time to sell a disappointing fund? In some cases, the answer may be obvious--say, you took on more risk than you could handle or something sinister happened and you no longer trust the fund company.

More typical, though, are questions that involve a gray area--when performance just hasn't stood out over a reasonable period of time. Moreover, what if the underachiever is one of your core holdings, you've owned it for years, and you have potentially large taxable gains? Further complicating the matter are often-promising moves by the fund company, such as a manager change or a short-term performance burst, that make you hopeful that a turnaround is in the works.

It's critical, though, that your core holdings truly earn their keep. With a plethora of great alternate choices, a core fund must be more than merely adequate to merit a place in your portfolio. That's especially true because they generally represent the bigger pieces of your portfolio. Of course, you don't want to pull the plug on a fund that's going through a slump when it still maintains all the fundamental attributes that argued for it in the first place (in fact, that may be the time to add to it). And you should be sure you're evaluating performance appropriately. But sometimes, it makes more sense to move on.

Following is a list of five of the largest mutual funds out there whose place in your portfolio may on shaky ground. This isn't a "Sell" list, but we do think shareholders here, and there are a lot of them, should be looking for some marked improvement in the near to intermediate term. Meanwhile, investors should start making a list of potential replacements.

 American Century Ultra (TWCUX)
Assets: $14.7 billion
One of yesteryear's highfliers, this once-aggressive large-growth fund has languished over the past decade, as a burgeoning asset base forced it to change course (moving up the market-cap ladder, for one). Despite its holding up better than most of its large-growth peers in the early 2000s, its three-, five-, and 10-year results through Dec. 21, 2006, land in the category's worst third. Making matters worse have been a slew of recent manager changes and analyst turnover, both at the fund level and throughout American Century in general. The new comanagers seem willing to return the fund to its more-adventurous ways, so there's a fairly straightforward test for this offering: In a large-growth rally, it should post superior results. If not, it may be time to part.

 Fidelity Fund  (FFIDX)
Assets: $7.8 billion
Fidelity Fund is the fund company's oldest offering, but it's certainly not the best. We wouldn't say that the large-blend fund has been horrible, but it's had mediocre returns (at best) and has been unexceptional from a risk standpoint. That's disappointing, especially considering the advantage the fund has from its cheap price tag: Its expense ratio is just 0.56%. Early in his nearly five-year tenure, manager John Avery hewed closer to the S&P 500 benchmark in terms of portfolio construction, and the fund thus acted a lot like that index (albeit with higher costs and inferior returns). But in the past couple of years, Avery has moved further away from the index. That means his stock-picking abilities are more on display now. It's too soon to judge Avery's capabilities just yet, but the next couple of years should help investors determine whether this fund can stand out in a category with a plethora of good, cheap core options.

 AIM Constellation 
Assets: $7.8 billion
AIM Constellation's story is similar to that of American Century Ultra: Aggressive smaller-cap fund grows into more-sluggish large-growth offering. But then parent company Amvescap found itself embroiled in the fund industry's market-timing scandal, and, while there have been improvements on the fiduciary front, its Morningstar Stewardship Grade has yet to reach an acceptable level. On the investment side, the fund has also undergone big changes. It has lost the manager who ran it during most of its growth phase, and several other AIM funds have merged into it. Its current managers have been at AIM for some time, so they are experienced. However, they've been transitioning over the past several years from a growth approach that had been more quantitative in nature to one that's more fundamentally based and somewhat sensitive to valuations. The managers began a turnaround at AIM Weingarten before that fund merged into this one--and AIM has been aggressive in bringing on experienced analysts. Further, expenses have come down. Now that the fund's ducks are in order, it's time to perform.

 T. Rowe Price International Stock (PRITX)
Assets: $7 billion
We don't fault any long-term investors for buying in here; it's a fund that has always seemed to stack the odds in its favor. The management team is respected and experienced, the fund's expenses are low, and like many other T. Rowe Price funds, it doesn't take on a huge amount of risk, so it can easily serve as a long-term core holding. The problem is that returns have been lackluster (relatively speaking; its double-digit returns in each of the past four years are certainly strong in absolute terms). Part of the issue has been the firm's analyst staff, which has seen some turnover and has generally been unremarkable. T. Rowe seems to recognize the fund as a turnaround candidate; the fund company has been hiring analysts overseas. The managers have also pared the number of holdings in the portfolio by about a third while remaining well-diversified. This should put more emphasis on stock-picking without adding too much risk. It's possible that these moves could turn the fund around, but there are many good substitutes, so you shouldn't feel compelled to stick around indefinitely.

 Vanguard U.S. Growth (VWUSX)
Assets: $5.9 billion
This large-growth offering has arguably been Vanguard's problem child for quite some time. Its performance over the past couple of decades has been spotty at best but generally downright dismal. Likely as a result, the fund has bled assets since the late 1990s when it housed nearly $19 billion. Vanguard hasn't exactly sat still since then: It's made a couple of manager changes over the years, bringing on AllianceBernstein in December 2002 then adding growth boutique William Blair and Company in April 2004 to run a third of the portfolio. While both management teams have decent to good records at their own fund companies, the fund has been unable to string together even couple of good years here so far--especially curious considering the Vanguard fund's superior cost structure. We do expect better things from the fund when high-quality mega-cap stocks are in favor, but as a core growth holding, it needs to remain more competitive when things aren't going its way.

Join us as we announce the winners of our Fund Manager of the Year and CEO of the Year awards live on CNBC. Christine Benz will announce the fund winners around 10:45 a.m. EST on Wednesday, Jan. 3, 2007. Pat Dorsey will announce the Morningstar CEO of the Year winner around 10:45 a.m. EST on Thursday, Jan. 4, 2007.