One of my goals this year is to build out the “mutual funds” section of this site, as my pieces on the Vanguard Wellington Fund is one of the most-searched topics here, and I’ve had a few conversations with readers that want to do their best to act intelligently within the confines of a 401(k) plan that does not offer a brokerage account option for you to truly self-direct your investments into the specific stocks of your choosing.
In that spirit, I’ve decided I want to spend some time analyzing some of the largest mutual funds that are offered to investors in this country, to determine whether or not they are worth consuming if they show up on the menu of options available in your company-sponsored retirement account.
The Growth Fund of America has one of the more legendary stories in realm of mutual fund lore, as it is a tremendous beneficiary of the halo effect created by the old management team that is no longer around. In the 1970s and 1980s, the Growth Fund of America had a dominant record of outperforming the S&P 500, often by as much as five, six, or seven percentage points in a typical year.
And as the Growth Fund of America’s excellent record began to become common knowledge among mutual fund investors, it saw a huge pile up in assets that made it difficult to outperform the S&P 500 and continue to maintain the excellent reputation that the fund had earned over time.
By the 2000s, it was becoming clear that The Growth Fund of America was no longer going fulfill the role of “fund that got you rich” but rather, the “fund that kept you rich.” When the bear market hit in 2001 and 2002 (and 2000 as well if you were dealing with certain tech stocks), the Growth Fund of America did not fall as much as the S&P 500, and this allowed the fund to hold on to its investors for the time being: fine, the Growth Fund of America won’t demolish the S&P 500, but you’ll keep more of your money when the stuff hits the fun, the new theory went.
Furthermore, the Growth Fund of America didn’t get caught up in the market timing scandal of 2003 in which some mutual fund houses admitted to tinkering with trades placed by shareholders during the day to benefit well-heeled and connected investors at the expense of the small retail investor that simply executed a sell order at some point during that day. This clean reputation, coupled with the fact that investors didn’t see their net worth get hit with the American Funds as much as the others in 2001 and 2002, was enough to keep people interested.
The Growth Fund’s legacy started to take a hit when the financial crisis of 2008 and 2009 erupted, simply because it didn’t do much better than the S&P 500 at that time. For instance, if you had put $10,000 into the Growth Fund of America in 2007 right before the storm started, then you saw that $10,000 turn into $5,300 by November of 2008 (for comparison, the S&P 500 would have turned your $10,000 into $5,500 by the end of November).
That was a big moment, as investors collectively concluded, “Hey, I’m capable of making half my money disappear just by myself. I don’t need to pay someone a 5.75% sales load to do that for me.” Over the past six years, it hasn’t been clear what the Growth Fund of America offers its investors in exchange for its steep fees: it used to beat the S&P 500 handily, but it doesn’t really do that anymore. Then, the narrative became: you won’t have to see your net worth fall as much with us when crisis strikes—that’s when we’ll prove our mettle. When that thesis didn’t hold up in 2008, investors began to consider The Growth Fund of America a glorified index fund that charged investors a 5.75% upfront load plus ongoing management expenses. That’s why you’ve seen the steady outflows over the past six years—the benefits of holding this fund are no longer readily apparent. The narrative is broken.
When I examined the portfolio’s holdings, I wasn’t particularly impressed. It owns 287 different stocks and bonds, and yet only sees fit to allocate 0.03% of the fund to Coca-Cola stock. The most dominant company in the world, which turns out 8-12% growth like clockwork, and the fund finds no room for it (although it does own some Coca-Cola bonds). The other company that seems to spit out 8-12% annual growth like clockwork, Johnson & Johnson, is not owned in the portfolio at all, either (although the fund does find some room for J&J bonds). And no Colgate-Palmolive, which has been growing its earnings by over 10% annually for the past century. The only exposure to Procter & Gamble is in the form of low fixed-income holdings.
The Growth Fund owns no Exxon. No ConocoPhillips. Only 0.09% in Chevron. Only 0.02% in BP. Only 0.13% in Royal Dutch Shell. Apparently, large oil companies that spew out profits and either grow their dividends aggressively or have high starting yields doesn’t have a place in the Growth Fund portfolio.
So what does the Growth Fund of America own? It has 4.5% of its assets in Amazon. Some people might like that given Amazon’s run-up in price this year. Personally, I wouldn’t want to see most of my assets in a company that is currently churning out $1 per share in profits and trading at 400x earnings. I’m not capable of understanding a valuation like that.
The Growth Fund does have some choices I like: 3.8% of the assets are in Google and 1.4% are in Philip Morris International. Google is one of the few companies that is able to grow north of 10% annually despite being valued at $370 billion. Philip Morris International is the spin-off of Altria, the best investment you could have made from 1926 through 2013 (I’m not sure what a 1926 investment would have turned into because Jeremy Siegel’s research on the topic stopped in 2006, but let’s put it this way: if you purchased $1 million worth of Philip Morris in June of 1970, you’d have almost $4 billion today and be one of the 1,000 or so richest people in the entire world).
The other bets in the Growth Fund of America essentially hinge on a continued recovery in the world economy. Think of Home Depot, Toyota, and stuff like that. None of these are bad investments, but they are the kind of stock selections that we are capable of coming up with ourselves.
There was a time when it made sense to own the Growth Fund of America. It turned $10,000 invested before the bear market of 1973 into a little over $1 million today, whereas the S&P 500 would have given you $550,000-$600,000 depending on the start date. In the early 2000s, the Growth Fund gave investors price stability, and that it made it tolerable to continue to own it even if it no longer beat the S&P 500. But now? No matter how sympathetically I try to run the numbers, I can’t get past the feeling that it’s just a fee-laden pseudo-index fund, taking large amounts of money out of your pockets to get the basic returns that you could get yourself nearly free of charge through a Vanguard S&P 500 Index Fund.
Originally posted 2013-12-31 01:53:29.