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Mutual Funds

Teamwork Pays Off

The American Funds family has sustained its success thanks to a team approach to management.

Fidelity Investments has shown the American Funds family the sincerest form of flattery by establishing a lineup of funds that are run by teams of managers rather than by individuals. This marks a big change for Fidelity -- and validates the consistently remarkable success American has enjoyed in achieving above-average returns from funds that can only be described as gargantuan. Let's take a closer look at American's success.

Broker-sold American funds weathered the bear market at the beginning of the decade in fine fashion, then enjoyed solid results in the rally that followed. Add the fact that they were untouched by the market-timing scandal, and you have a recipe for big inflows.

Big? Let's say massive. In 2000, assets held in American funds totaled $327 billion. Today, those same 30 funds hold almost $1.2 trillion, making American Funds slightly larger than the Vanguard Group, the number-two fund family. Ten of the 20 largest mutual funds belong to American, including Growth Fund of America, which is now approaching $200 billion in assets.

Path to the top. How did American get there? It's a simple formula, really. The firm had experience, talent, depth, long-term focus, low costs, a well-designed management structure, sound investment strategies and a solid culture. Although anyone could create a mock-up for a similar business, such a plan would be a bear to execute -- hence American's advantage.

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Two of those factors are crucial to American's ability to sustain its success in the face of massive asset growth. The team approach is a great way to run huge, actively managed funds, but you need a deep bench to pull it off. The typical American fund has something like eight managers. Each manager is assigned to a portion of the fund and runs his or her own shop independent of the other seven managers. Each manager usually runs a concentrated strategy, which, when added to a pool with the strategies of seven other managers, creates a widely diversified whole.

Although the funds are huge, divvying them up among managers keeps the pool manageable. In addition, American farms out a big portion, typically between 20% and 40%, to its analysts -- so it really has about 50 people running each fund. The firm has enough talented staff to do this. At American, analysts are prized and paid as much as managers. Thus, they are among the most experienced and best in the industry, which leaves you, the investor, in good hands.

Because American is so good at attracting and retaining talent, it has a wealth of expertise to fall back on as funds grow. If a fund is getting, say, $3 billion a month in new money from investors, the firm simply hands some of it off to analysts and adds a portfolio manager.

What's the limit? The rub here is that not even American has limitless resources of experienced investment professionals. At some point -- and it's hard to say whether that point has been reached -- the experience level of new analysts and managers will not be as high as in the past. In addition, the portfolios will grow to look more like indexes, and the funds will more frequently bump up against limits on the amount of stock in a single company the firm can own. American has attempted to address those limits by splitting itself once again into separate companies. However, it says that it's buying baskets of stocks rather than individual stocks in some cases -- a sure sign that assets are swelling.

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The above scenario hardly spells doom for the firm. American may have lost a bit of oomph, but don't forget about the many advantages that its competitors, including Fidelity, desperately wish they had.

Columnist Russel Kinnel is director of mutual fund research for Morningstar and editor of its monthly Fundinvestor newsletter.