The mutual fund world is a highly competitive one, with hundreds of fund shops peddling thousands of funds. Even with so many fund firms competing for your investment dollars, a few names dominate the scene. Firms like Vanguard, Fidelity, and American Funds collectively manage a few trillion dollars' worth of assets. As a result, they have been perpetual favorites among investors for years. However, some recent rankings have shuffled some of the offerings of one of these fund giants to the bottom of the pile.
In the basement
TheStreet Ratings recently released its ranking on 24 newer fund portfolios, and it didn't have kind things to say about American Funds' lineup of target-date funds. According to the ratings, of the shop's nine target-date funds, four of the funds received a C+ or C- rating, while the last five funds got a D+ mark. TheStreet.com states that it uses both performance and risk data when compiling its ratings. Like most target-date funds, the American Funds in question simply invest in other American Funds. So if their target-date funds are bad, does that mean that investors should rethink owning any American Funds?
Well, don't go dumping your shares just yet. There are a couple of things you should realize with respect to these rankings. First of all, they are based on just three years of performance and risk data. That's really not a long enough period of time over which to judge a fund's long-term potential. Also, while performance and risk are vitally important aspects of a fund's character, it does leave out other more qualitative factors, such as management structure and tenure. American Funds boasts one of the most well-run management teams in the business, which is something that can't be captured in a quantitative measure.
Lastly, consider that it's likely that the biggest reason why these funds are being penalized over this time frame is that they trailed their benchmarks by a wide margin in 2008's challenging market. But the majority of target-date funds encountered the same problem in that bear market, even prompting lawmakers to consider new legislation to better regulate the target-date fund industry. So even though American Funds' target-date funds may not have come through the past few years with flying colors, don't discount this shop's investment know-how.
The devil is in the details
It is true that the American Funds lineup suffers from one big flaw -- a lack of small-cap coverage. The fund only has one small-cap focused fund, which invests across the globe. As a result, the shop's target-date funds are heavily skewed toward large- and megacap stocks. This has hurt the funds because smaller names have done especially well as the market has rebounded in the past year. If you do own an American Funds target-date fund or are in a retirement plan dominated by American Funds options, make sure you've got small-cap coverage elsewhere. In this case, consider using the small-cap exchange-traded funds iShares Russell 2000 Index
Of course, this discussion does highlight one of the downfalls of target-date fund investing in general -- you can't control the underlying funds you buy or their specific allocations. That means you could get stuck with a few stinker funds. And even if you think large-cap growth names are going to take off, you can't get more exposure to that sector if the manager doesn't agree. While target-date funds can definitely be useful for investors who want a helping hand with their investments or who prefer a hands-off approach, most investors would do better picking and choosing their own funds and creating their own asset allocation. Fortunately, American Funds offers plenty of great choices to do just that.
Cream of the crop
If you're a fan of American Funds, don't worry too much about these negative ratings. I'm still a big fan of many of its funds, assuming you can purchase them without paying the front-end load (which you usually can do within a qualified retirement plan). Two of my favorites are American Funds Growth Fund of America (AGTHX) and American Funds EuroPacific Growth (AEPGX). Growth Fund of America is an especially timely choice right now because it focuses heavily on growth-oriented securities, especially technology, which is an area that's ripe for the picking. As the economy gains strength, I expect top fund holding Microsoft
EuroPacific Growth may be a slightly riskier option right now, seeing as it devotes nearly half of its portfolio to developed Europe. This area may be under pressure in the near future as the continent works toward resolving the Greek debt crisis. However, the fund also invests heavily in emerging-market names, which should have greater growth potential going forward. Some of my favorites here include Mexican communications company America Movil
No fund shop is perfect, but American Funds is still one of the better choices of fund families when it comes to building your portfolio. As long as you can avoid paying a front-end load, many of the shop's offerings would be a fine fit for almost any investor.
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Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. Apple is a Motley Fool Stock Advisor pick. America Movil is a Motley Fool Global Gains choice. Motley Fool Options has recommended a diagonal call position on Microsoft, which is a Motley Fool Inside Value pick. The Fool owns shares of and has written puts on Oracle, and has a disclosure policy.