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Should You Buy American Funds' Laggards?

Seeking out contrarian ideas in a red-hot fund family.

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A version of this article appeared in the May 2007 issue of theMorningstar American Funds Family Report, our monthly newsletter dedicated to helping American Funds investors find superior long-term investment opportunities. To review a risk-free trial issue of our American Funds Family Report, click here. Fund Family Reports on Vanguard and Fidelity Funds are also available.

In search of investing opportunities at the wildly successful American Funds, I took a closer look at the few of the shop's funds that have underperformed their competitors in recent years. The reason is fairly simple: Funds that have lagged their rivals may now be more attractive from a contrarian perspective, depending on the reasons for that poor performance, than funds with very strong performance. That's particularly true now because, until very recently, many of the same trends had persisted for years in the equity and fixed-income markets: Small caps and value stocks had vastly outperformed their larger, more growth-oriented counterparts, high-yield bonds had crushed investment-grade debt, and risk-taking in general has been well rewarded. I think those trends, as they have lately, will probably continue to reverse. Funds that have been going against that grain, and have good fundamentals as most American funds do, have a good chance of outperforming in the coming years.

To identify these laggards, I screened all American Funds on relative performance for the three- and five-year periods ended Sept. 30, 2007. (Shorter-term performance measures aren't very useful.) I focused on funds that have lagged their typical category rival over both periods. Not surprisingly very few of American's funds passed that screen; even those with out-of-favor approaches often beat their peers through a combination of good security selection and low costs. I did, however, find four funds that fit the bill:  American Mutual  (AMRMX),  High-Income Municipal Bond  (AMHIX),  New World  (NEWFX), and  Washington Mutual Investors (AWSHX). I'll tackle these one by one.

Greg Carlson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.