Fund Spy7/10/2006 12:00 AM ET

Rating the best of the biggest funds in 2006

Here are Morningstar's first-half grades for 10 of the biggest actively managed mutual funds. Did American Funds deliver the goods?

By Morningstar

The first half of 2006 is in the books, and what a doozy it was. We began with a great rally before rising inflation and a newfound aversion to risk sent markets plummeting. Then we rebounded a bit. Just like a roller coaster, we've soared and plunged, only to end up where we started.

The indexes tell the story: The S&P 500 ($INX) and Morningstar U.S. Market Index ($MSTAR) (a broad measure of the overall market) finished the first half up 2.7% and 3.3%, respectively. Eight of the nine style box indexes had positive gains, but large growth shed 3.1%. The best spots were small core (up 10.2%) and large value (up 8.4%). Rising inflation hurt bonds as the Lehman Brothers Aggregate lost 0.7% while a falling dollar made up for flat international equity markets to boost the iShares MSCI EAFE Index (EFA) 10%.

Let's take a look at how the 10 largest actively managed funds fared amid those wild swings in the first half. I'll give each one a grade for how they fared given their investment approaches. Of course, there's much more to a fund than six months' worth of returns, so I'd encourage you to read our analyses to see whether we think the funds are attractive investments for the next 10 years.

1. American Funds Growth Fund of America

When large growth is the worst-performing category -- as it was in the first half and has been for the better part of the last five years -- GFA is a pretty good bet to hold up better than its peers.

That's because it also has a lot of blend and value stocks, as well as a slug of cash. (A slug of cash is a recurrent theme for most of the American Funds on this list.) In fact, American Funds Growth Fund of America's (AGTHX) 2.7% return beat 90% of its large-growth peers for the first half. A bunch of energy stocks, including Schlumberger (SLB, news, msgs), helped the fund stay out of the red. Management also made some great picks in other sectors, including Oracle (ORCL, news, msgs) and Best Buy (BBY, news, msgs).

As I said, this market was favorable to the fund's relative performance, but even so I'll give it an A for the first half. Check out Paul Herbert's analysis. (Registration required for this and other Morningstar fund takes.)

2. PIMCO Total Return

What happens when inflation spikes and a bond fund manager is expecting inflation to remain low? It gets stung, of course.

That's what happened in June, as PIMCO Total Return (PTTRX) fell below the Lehman Brothers Aggregate's returns and is barely ahead of that of its average peer for the year to date. The fund's 0.7% loss means it will have to turn in a better second half to finish in its accustomed spot ahead of the index and most of its peers.

Considering this fund (at least its institutional share class) starts out with a big cost edge on most intermediate-bond funds, the first half is pretty disappointing. Even so, the fund is only behind the index by 20 basis points or so, and it can easily make up that ground. First-half grade: B-. Does Karen Dolan think this fund is a buy? Click here.

3. American Funds EuroPacific Growth

Ouch. American Funds EuroPacific Growth's (AEPGX) 6.8% gain is only half that of the MSCI EAFE Index's, leaving it in the foreign large-blend category's cellar.

If it's any comfort to shareholders, the source of this year's weakness is the same thing that drove strong returns in recent years. The fund has a hefty 25% of assets in emerging markets. Spurred by rising rates, investors have started to take notice of the fact that emerging markets offer very little margin of safety at their current high valuations. That's led to a nasty little sell-off, and this fund has suffered for it. Given its size, it might be tough for this fund to move out of an area -- in particular, emerging markets, which can be hard to convert into cash -- quickly, even if it wanted to. First-half grade: C. Click here for Morningstar's take.

4. American Funds Investment Company of America

Just as Growth Fund of America has more invested outside the large-growth square of the style box than the competition, American Funds Investment Company of America (AIVSX) has more in blend and growth than most value funds.

Yet the fund still produced strong relative performance in the first half, even though large value was the best spot in the style box. Schlumberger and Oracle were big successes for this fund, too, but so were Caterpillar (CAT, news, msgs) and AT&T (T, news, msgs). And of course, the cash stake didn't hurt. In all, the fund returned 5.7%. First-half grade: A. Click here for Kerry O'Boyle's take.

5. American Funds Washington Mutual

American Funds Washington Mutual (AWSHX) is a little more firmly in the value camp than Investment Company of America (ICA) because of its strict dividend requirements. Thus, its 5.2% returns, which have beaten about three-fifths of its peers, are not a big surprise.

A strong second quarter for regional Bell operating companies and electric utilities, a natural area for a dividend-focused fund, was a big help. First-half grade: B. Click here for Kai Wiecking's take.

6. American Funds Income Fund of America

American Funds Income Fund of America (AMECX) gained 6.8% in the first half, placing it in the top 3% of moderate-allocation funds for the year. Having a mere 25% of assets in bonds helped limit its losses. Having a rather pure value focus was also a big help. Check out this fund's ownership zone in comparison with that of Investment Company of America. This fund is neatly tucked into the upper-left corner of the style box whereas ICA is spread out rather evenly from value to growth.

Stop me if you've heard this before: Telecom and electric utilities were a big help as were some cyclical plays. First-half grade: A. Click here for Morningstar's long-term view.

7. American Funds Capital World Growth & Income

American Funds Capital World Growth & Income's (CWGIX) 6.6% return lags EAFE but it still beats most world-stock funds.

All together now: Telecom, electric utilities and energy bets led the way for the fund. Being underweight on tech and health care was a big help, too. First-half grade: B. Click here for our analysis.

8. American Funds Capital Income Builder

Despite owning some laggards like Fannie Mae (FNM, news, msgs), Altria Group (MO, news, msgs)and Citigroup (C, news, msgs), American Funds Capital Income Builder (CAIBX) is up 6.7% for the year. That's better than about three-fifths of the world-allocation category.

Once again, this fund was positioned well on a sector basis, with lots of phone companies and utilities and not much in tech or health care. It also scored success with top holding E.ON (EON, news, msgs), a German energy giant. First-half grade: B. Click here for our take.

9. Fidelity Contrafund

Not sure what this non-American Fund is doing here, but the Fidelity Contrafund (FCNTX) had a great first half. Its 4% return placed it in the top 5% of its peer group.

Just like the American Funds, manager Will Danoff was light on tech and long on energy. His top picks were Schlumberger, BHP Billiton (BHP, news, msgs) and NII Holdings (NIHD, news, msgs). Unlike the American funds, Contrafund closed to new investors in the first half. First-half grade: A-. You can't buy it if you don't already own it, so is it a hold?

10. Dodge & Cox Stock

Dodge & Cox Stock (DODGX, news, msgs) has been closed for a while, and it enjoyed another good period of performance. Its 6.2% return beat about four-fifths of the large-value universe. For a change, this fund actually has a fair amount in health care and tech and is light on energy. Big bets on Comcast (CMCSA, news, msgs), Sanofi-Aventis (SNY, news, msgs) and Hewlett-Packard (HPQ, news, msgs) paved the way to a strong start in 2006.

Dodge has been selling energy and materials stocks on valuations and buying more cheap mega-caps such as Sanofi. That gives the fund a good chance at success when market trends reverse. First-half grade: A. Click here for our take on its prospects.

By Russel Kinnel

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