By Jessica Toonkel

At the end of 2007, it was the largest fund company, with $1.2 trillion in assets.

After several years of lagging performance, however, investors pulled $82 billion from American Funds -- 9 percent of total assets -- in 2011, according to Morningstar figures released on Friday.

That was an industry record for dollar outflows and the largest percentage loss of total assets ever for any fund company the size of American Funds, according to Morningstar. The $82 billion dwarfs the next-highest amount, $28 billion at Fidelity Investments. Meanwhile, the largest fund company, Vanguard Group, had $44 billion in inflows.

But a number of people who have spoken to officials at American Funds said executives at the Los Angeles company, while not exactly pleased with the high level of redemptions, did not seem ruffled. Even with the massive outflows, American Funds has only slipped one place in terms of assets, according to Morningstar.

A spokesman for the company, which is owned by Capital Research and Management, stood by its investment process and said American Funds remained committed to its strategy of offering large, diversified funds.

And while American Funds may still be a fund behemoth, some wonder how long the firm can go without changing its ways.

"Advisers want alternatives, absolute returns and all of those things that now make up 20 percent of an investor's portfolio," said a former American Funds employee who requested anonymity. "Can they afford to wait that long to see if flows come back, and at what expense?"

BUSINESS MODEL WOES

American Funds, sold only through advisers, built its business around brokers who charged commissions and continues to offer its funds with loads, or front-end sales charges.

But as more advisers have ditched commissions and have begun charging fees based on how much money they manage for a client, the fund company has less to offer than boutique firms offering smaller, more-nimble niche funds that better fit into advisers' model portfolios.

While its peers were rushing to introduce technology funds in the late 1990s, American Funds stayed on the sidelines. And lately, as fund companies dive into alternative investments, niche funds and exchange-traded funds, American Funds has not.

Indeed, the $863 billion fund company has been reluctant to bring new investment products to market and was slow to make changes to avoid big losses during the financial crisis. At the same time, equities and actively managed growth funds -- its sweet spot -- have fallen out of favor.

While companies like BlackRock Inc have been able to capture investor cash by offering a diverse investment lineup and ETFs [ID:nHDW019988], American Funds has not.

For its part, American Funds spokesman Chuck Freadhoff said chasing product fads and introducing niche products was not how American Funds does business and never would be.

But many fee-based advisers said American Funds did not offer the low-cost, high-performance funds they can easily plug into their investment models.

"Twenty years ago, I wouldn't get paid if I switched from a load to a no-load fund," said Steve Johnson, a Draper, Utah-based adviser with Raymond James Financial Services Inc.

Johnson sold out of Americans Funds' flagship Growth Fund of America over the last six months. "Today there isn't a lot of loyalty to any one firm. I can switch in a heartbeat."

CHANGING LANDSCAPE

Sixty-four percent of advisers said the majority of the assets they managed were in fee-based accounts at the end of 2010, compared with 49 percent at the beginning of 2007, according to research firm Cerulli Associates.

American Funds' performance began to suffer just as many advisers were evaluating their fund lineups as part of that change, said Neil Bathon, a partner in mutual fund research and consulting company FUSE Research Network LLC.

"Advisers are under more pressure to show that they are earning their 1 percent fee," said Scott Smith, associate director of Cerulli Associates. As a result, they tend to switch funds at any hint of underperformance.

More fee-based advisers have also started using the investment models of the brokerage firms they work for. Those tend to include very precise strategies.

"American Funds doesn't work well in those models" because its funds are large and diverse, Bathon said.

What's more, many also are opting for ETFs instead of mutual funds. American Funds does not offer ETFs, which have become a more than $1 trillion market.

FALL FROM GRACE

Founded in 1929, American Funds, built its reputation by putting each fund under a group of "portfolio counselors," who each manage a sleeve of money and are paid primarily based on performance of their portion of assets.

That approach and a refusal to chase fads once served the company well. It said the number of advisers selling its funds had doubled to 200,000 between 1999 and 2006.

Advisers were caught off-guard in 2008, when they say American Funds did not do enough to shore up performance after the market crash of 2008. The firm's Growth Fund of America was down 39 percent that year; the S&P 500 was down 37 percent. The fund was heavily invested in financial services companies and the debt of Fannie Mae and Freddie Mac.

"I felt like they didn't protect me or my clients," said an adviser who requested anonymity because he did not have permission to speak to the media. He has not sold American Funds since.

The funds have continued to falter. The Growth Fund of America has trailed its peers for the past one, three and five years, and it accounted for $33 billion of 2011 outflows.

Indeed, 37 percent of the company's equity funds have trailed their benchmarks on an average trailing five-year period, 66 percent have underperformed for the past three years and 72 percent have for the past year, according to Morningstar.

All of American Funds' bond funds have underperformed their benchmarks on an average trailing five-year period. Forty-two percent have underperformed for the past three years and 93 percent the past year, according to Morningstar.

One reason: The Bond Fund of America had 27 percent in Treasuries, higher than most of its peers, at the end of 2010. It dialed down its position to 19.8 percent last summer, just as Treasuries were tallying.

In more bad news, many advisers and retirement plans are eschewing actively managed funds, a hallmark for American Funds, in favor of index funds. In 2011, investors pulled about $9.4 billion from actively managed funds, while index funds took in $76.4 billion.

In 2010, 14 401(k) plans with more than $1 billion in assets under management dropped Growth Fund of America from their plans, while only three added it, according to research firm BrightScope.

For American Funds, that is a big symptom of the larger problem, experts say. Advisers and retirement plans have other, better-performing choices.

Although the company stands by its investment approach, Freadhoff said, it recently filed to introduce a suite of asset allocation funds in response to advisers' demand. Instead of investing in a number of funds to get certain exposures, advisers can invest in one funds of funds, he said.

Still, that might not be enough for American Funds to mount a strong comeback anytime soon.

"They are not the type to launch new funds," said Russel Kinnel, director of mutual fund research at Morningstar, "and they are not close to any sweet spot where flows are going."

(Reporting by Jessica Toonkel; Editing by Jennifer Merritt, Walden Siew and Lisa Von Ahn)