Is a gem hiding in your 401(k)?

I wrote two weeks ago about delving more deeply into your company retirement plan for possible gems hidden among the run-of-the-mill options that dominate most 401(k)s. I did this myself in December with my wife's plan and uncovered a real jewel.

It is American Century Heritage (ATHAX), a midcap portfolio with an amazing record of success. It was up 45.4% in 2007 and an average of 13.7% annually in the 20 years since it was launched. Over the past three years, it has beaten the S&P 500 Index ($INX) by nearly 18 percentage points a year.

I love midcap stocks. These are well-established businesses that have survived the competition of their youth but remain the relatively youthful competitors of lumbering giants. Their market capitalization falls between $1 billion and $10 billion. In 2007, when the S&P 500 (all large-cap companies) was ahead 5.5% and the S&P Small Cap 600 ($SML.X) was down 0.5%, the S&P Mid Cap 400 ($MID.X) spurted 7.3%.

And among midcap funds, it's hard to beat the American Century portfolio. Its managers have included James E. Stowers Jr. and James Stowers III, members of the company's founding family, and the current helmsmen have done some spectacular stock picking.

But be warned: This fund is for patient investors only. Its boldness takes it far away from the average, sometimes in the wrong direction. It slid 5.7% in the first six trading sessions of this year, even more than the S&P 500. "Unless you can ride out the inevitable bumps," warns Morningstar analyst Christopher Davis, "it won't be worth owning."

The investment strategy

Co-manager David M. Hollond says many names like these -- the fund owns about 80 stocks -- are benefiting from rapid growth in China, India and other emerging-market countries. "Their middle class is growing very rapidly and becoming much wealthier, driving huge demand for infrastructure, airports, airplanes, roads, chemical plants, refineries and pharmaceutical plants, as well as meat, tractors, fertilizers and seeds," he says.

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After identifying promising sectors, the American Century team burrows to find the companies with the strongest numbers. "We invest in companies exhibiting accelerating revenue and earnings that are sustainable," Hollond says. "This is bottom-up, fundamental research."

This fund also has proved adept at finding hot companies within cold sectors. Consumer stocks, for example, are taking a whipping as the economy slows. But GameStop (GME, news, msgs) is burgeoning, with sales up an average of more than 35% in each of the past five years and earnings rising nearly 87% annually.

"We look at GameStop as not having to make a bet on which (video game) consoles are going to win, because they sell all of them," Hollond says. "It's obvious the consumer is cutting back on certain things, but our bet is that this is an area they're not going to cut back because video games are such a huge part of people's lives these days."

A tax bite

I found the fund in my wife's 403(b) plan, inside an annuity -- that plague of public and not-for-profit plans. It is labeled American Century VP Capital Appreciation Fund, but it is Heritage. An annuity is an insurance contract wrapped around an investment portfolio, typically guaranteeing your heirs will at least get what you put in -- for a notoriously high fee.

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In my wife's Mutual of America plan, the costs are not too severe. Her version of the fund went up 45.13% last year, just 24 basis points less than Heritage A shares (up 45.37%).

By the same token, Heritage itself is expensive; the annual fee of the mutual fund's A shares is 1.25%. The institutional version, with a $5 million minimum and a ticker symbol of ATHIX, charges only 0.8%.

Continued: Vanishing act

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