We address the issue of providing highly informative and comprehensive annotations using information revealed by the structured vocabularies of Gene Ontology (GO). For a target, a set of candidate terms for inferring target properties is collected and form a unique distribution on the GO directed acyclic graph (DAG). We propose a novel ontology-based clustering algorithm — CLUGO, which considers GO hierarchical characteristics and the clustering of term distributions. By identifying significant groups in the distributions, CLUGO assigns comprehensive and correct annotations for a target. According to the results of experiments with automated sequence functional annotations, CLUGO represents a considerable improvement over our previous work — GOMIT in terms of recall while maintaining a similar level of precision. We conclude that given a GO candidate term distribution, CLUGO is an efficient ontology-based clustering algorithm for selecting comprehensive and correct annotations.