Growth Fund of America: Defying the Rules

You've got to hand it to the American Funds. No other fund company has ever come close to handling such a gargantuan asset base as that of Growth Fund of America (AGTHX), let alone with as much grace and ease.

The $182 billion beast towers over its nearest rival, EuroPacific Growth, another American fund, by about $70 billion. And, although we'd be hard pressed to recommend a fund that charges a 5.75% up-front sales charge, this wonder of the investing world has produced remarkably solid returns.

American Funds, which runs seven of the ten largest stock mutual funds, is no stranger to managing its own girth. Assets in the 12 American equity funds, which are run by Capital Research and Management Company, total almost $800 billion.

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Blame the bloat on investors' penchant for chasing returns. Of the 11 American stock funds that have been around for at least ten years, all rank in the top 50% of their category for annualized ten-year returns, and nine rank in the top 25%. The American Funds family sports the top returns, as a family, for the past ten years, according to Lipper.

From its inception in 1973 through February 6, Growth Fund of America returned 15.4% annualized, beating the Standard & Poor's 500-stock index by an average of four percentage points per year.

Credit Capital Research's multiple manager approach for the success. Each of 11 "portfolio counselors" manages a slice of Growth Fund. A group of analysts directs a 12th slice of the fund.

Each counselor acts independently. For example, Blair Frank, a counselor for the fund since 2001, likes to buy "companies that are growing their customer base, products, market share and profitability," according to a company report. Donnalisa Barnum, who also joined in 2001, prefers "strong research and development, ability to raise prices or cut costs and a strong, positive corporate culture."

So all of the managers have the same objective -- to buy growing companies -- but they can take their own tack to get there.

This is not to imply that there's an oversight vacuum. Capital Research's "Investment Control Group" monitors all workings within the fund, acting "like a traffic light" for stock transactions, says Maura Griffin, a spokesperson for American Funds.

So if one manager wanted to sell a stock, he would offer it first to the other managers for their segments of the portfolio. That approach holds down transaction costs and overall turnover (the fund owns each stock in its portfolio for four years, on average).

Investment Control also will flag when one specific holding is getting too large, as different managers may hold the same stock in their slices. Google (symbol GOOG), at 3% of assets, was recently Growth Fund's largest holding.

The result has been excellent individual stock selection and a bit more of a value bent than is found in the typical growth fund. That contributed to the fund's winning streak from 2000 to 2006.

It beat more than 80% of funds that invest in large, fast-growing companies in each of those calendar years, as investors rewarded undervalued stocks over fast-growers in most of those years (it also beat more than 80% of its peers in 1998 and 1999, when growth prevailed). Growth's streak came to an end in 2007, when it trailed most of its peers.

That Growth Fund hasn't morphed into a de facto index fund is another feat.

"I would say, even with its huge asset base, it looks significantly different than the S&P," says Morningstar analyst Greg Carlson. "And it's not heavily focused on tech and health care like other growth funds," he adds.

Longstanding holding Altria (MO), and the fund's comparatively high 15% stake in energy companies, bear more marks of a value orientation.

Carlson says the fund's enormousness creates challenges. For example, "it makes it difficult to invest in mid- and small-cap companies, even with the individual managers," he says. American has never closed a fund before and says it has no plans of closing Growth Fund.

Furthermore, Carlson says portfolio counselor Jim Rothenberg, who has been with Growth Fund since the late '80s, noted in a recent Morningstar conference that there has been a change in manager approach. "Some of the managers are buying clusters of companies more often than individual holdings," Carlson says.

The shift may signal that managers are targeting small sub-sectors, such as broadband companies, to generate returns, rather than specific companies. Such a shift could be a bit worrisome, as Growth Fund has thrived because of individual stock picking, rather than sector forecasts.

But who knows? If any fund can defy the rules without breaking a sweat, it's Growth Fund of America.