The 10 Hottest-Selling Mutual Funds Are Also Keepers

Well done, average fund investor.

A look at the top selling funds for 2006 (based on preliminary data) shows that fund investors en masse were making better selections than usual. As long as mutual funds have been around, the biggest mistake fund investors have made is chasing performance at the expense of fundamental factors such as management, strategy, and expenses. The basic flaw in doing that is that you're buying yesterday's winners rather than focusing on the things that actually help you pick tomorrow's winners. Check out the record of hot-selling Internet and tech funds from 1999 to see where that path leads.

For 2006, though, I was pleased to see that the trendiest stuff didn't make the list. No China funds, no Russia funds, not even a real-estate fund. Rather, the top-selling funds were broadly diversified, well-managed, and low in cost. True, there was an emphasis on funds with strong recent returns and many of the funds suffer from asset bloat, but those are minor concerns compared with buying supertrendy supercostly niche funds like the top-performing China funds.

I'll take a look at each fund individually, but I'll cut to the chase first and say that all 10 are worth holding on to if you own them. Most are so large that they ought to close, but they're still solid funds.

 American Funds Growth Fund of America (AGTHX)
The hottest-selling fund is also the biggest. Getting huge didn't turn out so well at  Fidelity Magellan (FMAGX) as asset bloat eventually became an anchor around its managers' necks. I'd love to see this fund close but it's still a cut above the average fund. American has deep manager and analyst teams and its system of having individual managers operate independently reduces the impact of asset bloat. Although some American Funds have seen their performance slow, this one has been on a tear. Hence the inflows. So, those flows are a handicap, but you could do far worse than a low-cost, well-managed, broadly diversified fund like this one.

 American Funds Capital World Growth & Income (CWGIX)
 American Funds Capital Income Builder (CAIBX)
 American Funds EuroPacific Growth (AEPGX)
There seems to be some theme here, but I can't put my finger on it. I like seeing funds like these on the best-seller list because they're so broadly diversified. Capital Income Builder has the added diversification of a bond stake, which should help limit the downside when the next correction comes. As for our take on American more broadly, check out the recent article by Paul Herbert, Morningstar's lead analyst for American Funds. 

 Dodge & Cox International Stock (DODFX)
This may be my favorite fund on the list, although as a fundholder I'd like to see it close this fund fairly soon. I get nervous when a fund draws this much attention. Still, Dodge has shown it will close a fund when assets threaten to become a problem. I also appreciate Dodge's thoughtful letter to shareholders on the subject. The appeal here is obvious. Dodge has great management, is an outstanding steward of investors' capital, and delivers low expenses by staying out of No Transaction Fee networks.

 Vanguard Total Stock Market Index (VTSMX)
I love seeing this fund on the best-seller list. First off, index funds don't have a problem with asset growth like actively managed funds, so it's quite sensible for them to be large. Second, large-blend funds like this one haven't had great returns, so this is evidence that some Vanguard investors are making a sober decision based on the fundamentals rather than chasing returns. It's a boring low-cost fund that is quite effective at getting investors to their goals.

 Fidelity Diversified International (FDIVX)
This is another low-cost diversified fund but I wish it weren't still drawing such huge flows. Fidelity closed it in October 2004 but strong returns have continued to draw more money from existing shareholders, particularly those in 401(k)s. This and a similar experience at  Fidelity Low-Priced Stock show that funds widely dispersed in 401(k) plans need to be closed well in advance of the tipping point where assets become a handicap.

 PIMCO Total Return (PTTRX)
Run by two-time Manager of the Year Bill Gross, this is one of the best bond funds in existence. It's also the biggest as assets now top $100 billion. Asset growth limits the value that Gross and his team can add through individual bond selection, but Gross and the others have found other ways to add value. The fund actually had an off year in 2006 as it lost to the Lehman Brothers Aggregate by a small amount, but I wouldn't worry. The one catch is that this fund's retail shares are kind of pricey, so if you want to buy in, go with  Harbor Bond (HABDX). I have a modest investment in PIMCO Total Return through Morningstar's 401(k).

 American Funds Fundamental Investors (ANCFX)
At $38 billion, this is one of the smaller stock funds in the American lineup. It enjoyed a smoking 2006 thanks to a big bet on foreign stocks among other things. There's a modest advantage to having a smaller American fund in that it's less likely to add more junior portfolio managers and it can hold fewer stocks.

 Davis New York Venture (NYVTX)
This is another fund that boasts great stewardship and investing prowess. Chris Davis and Ken Feinberg are outstanding investors who employ a Buffett-influenced strategy focused on finding well-run companies trading below their intrinsic values. At $44 billion, plus billions run in similar strategies, it may be time for this fund to close, too. I own the no-load version of this fund:  Selected American (SLADX).

The 10 Most-Popular Fund Spys of 2006
Keeping with my theme of what was popular in 2006, here are the 10 most-popular Fund Spys of the year.

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