Critics seize upon Vanguard's handling of U.S. Growth Fund

The Vanguard Group Inc.'s handling of its lackluster U.S. Growth Fund threatens to tarnish the company's reputation for putting investors first. First, there was an angry letter that John Brennan, chairman and chief executive of the Malvern, Pa.-based fund manager, fired off in April. In it, he chastised an unhappy investor who wrote to Vanguard, questioning it and Mr. Brennan's integrity for recommending U.S. Growth despite years of poor performance. "To assert that I — and specifically Vanguard — would place business ahead of clients' interest is an outrageous statement, and one about which you should be ashamed," Mr. Brennan wrote. The letters to and from Mr. Brennan were obtained by Daniel P. Wiener, the Brooklyn, New York-based editor of The Independent Adviser for Vanguard Investors.

'MORE OF THE SAME'

Mr. Wiener, who published portions of the letters in his newsletter, declined to disclose the investor's name. Publication of the letters was followed by news July 25 that the $4.7 billion U.S. Growth Fund will have new managers. Vanguard watchers, however, dismissed the move as inconsequential. "From the little that we have seen so far, it's more of the same," said Mr. Wiener, who is also chief executive and chief investment officer of Adviser Investment Management Inc. of Newton, Mass., which oversees about $1 billion in assets. AllianceBernstein LP of New York, which has advised the U.S. Growth Fund since 2001 and manages about two-thirds of its assets, will still manage the fund along with Chicago-based William Blair & Co. LLC, co-adviser to the fund since 2004. The only difference is that AllianceBernstein executive vice president James G. Reilly and senior vice president P. Scott Wallace will manage the AllianceBernstein portion of the funds instead of senior vice president Alan E. Levi, who is preparing to retire. The move will likely do little to improve the fund's performance, Mr. Wiener said. "I think Vanguard is hiding its head in the sand," he said. Year-to-date through July 31, the fund had lost 10.55%, and it had a one-year return of -6.85%, an annualized three-year return of 2.17%, an annualized five-year return of 5.62% and an annualized 10-year return of -3.07%. The fund's benchmark, the Russell 1000 Growth Index, was down 10.79% year-to-date, had a one-year annualized return of -6.29%, a three-year annualized return of 3.57%, a five-year annualized return of 6.39% and a 10-year annualized return of 0.83%. Vanguard isn't the only large fund complex to have an underperforming offering. Such funds are common. U.S. Growth, however, poses a special problem for Vanguard. It represents about 7% of the $13.55 billion Vanguard Star, a fund of funds that invests in 11 Vanguard funds. Star has had relatively solid performance, but that doesn't excuse it from taking such a big position in U.S. Growth, Mr. Weiner said. "It's not doing [investors] any service to have Star supporting U.S. Growth," he said. Another problem that U.S. Growth poses for Vanguard has to do with the firm's reputation as an index fund manager, not an active fund manager. "There's a perception that their actively managed funds don't perform," said Steven A. Bové, president of Lebrigh Life Planners LLC, an Oldsmar, Fla.-based adviser with $10 million under management. It is a false perception, he said. But Vanguard's failure to straight-en out a high-profile fund such as U.S. Growth hasn't helped it shake that perception, said Mr. Bové, a former Vanguard manager, who left the company in 2001. At its height in August 2000, total assets in U.S. Growth were $22.3 billion. Investors began to flee the fund when performance faltered. In June 2001, Vanguard hired AllianceBernstein to replace Lincoln Capital Management Co. of Chicago as the fund's manager. Vanguard adopted a multimanager approach to the fund in June 2004, hiring Blair to run a portion of it. Because the addition of Blair is still relatively recent and growth- oriented investing has been out of favor for so long, Vanguard is inclined to leave the managers in place, said Joseph Brennan, a principal with Vanguard and head of its portfolio review group. He is not related to John Brennan. "We have two managers that are very complementary," Joseph Brennan said. Since AllianceBernstein and Blair took over the fund, performance has improved, he said. The fund's long-term performance is still poor, but investors forget that AllianceBernstein and Blair aren't responsible for its 10-year track record, Mr. Brennan said. "The people managing it are not responsible for those early years," he said.

DOESN'T STAND OUT

Regardless, the fund still doesn't stand out among its peers, said Dan Culloton, an analyst for Morningstar Inc. of Chicago. "The bottom line is, neither [AllianceBernstein nor Blair] has covered themselves in glory in recent years," he said, adding that he is puzzled as to why Vanguard doesn't remove one or both. And Vanguard isn't averse to replacing managers. The firm in March cut loose Boston-based Grantham Mayo Van Otterloo & Co. LLC, which had managed portions of the $10.17 million Vanguard Explorer Fund and $821 million Vanguard U.S. Value Fund since 2000. It was a move that Mr. Culloton said was surprising given that Grantham is such a highly respected manager. "From our perspective I still don't know why exactly they did it," he said. Vanguard remains mum. "We really don't comment about actions taken with respect to past advisers," Mr. Brennan said. E-mail David Hoffman at dhoffman@investmentnews.com.