Vanguard Draws Investors By Keeping a Lid on Costs

The Vanguard Group, the nation's second-largest fund family, ison a roll:

Since the start of the year, the Valley Forge, Pa., fund grouphas boosted its mutual fund assets by $25 billion, entrenching itselfas the industry's No. 2 firm behind Fidelity Investments of Boston.

Vanguard's broad lineup of low-cost, plain-vanilla bond fundsavoided the bad publicity that hit fund companies last year afterthey dabbled in such esoteric areas as derivatives and Latin Americandebt.

Vanguard's flagship Index Trust 500 Portfolio, which tracks theStandard & Poor's 500 index, has performed brilliantly this year,besting 90 percent of actively managed stock funds so far andboosting the arguments in favor of indexing, in which Vanguard is aleader.

The company on Monday plans to unveil four aggressive stockfunds to complement its mostly staid mix of equity portfolios. Thesehave been named the Horizon funds.

"It's rare to have all of our cylinders hitting together, butit's happening for us right now," says John Bogle, the company'sfounder, chairman and chief executive officer.

Maybe "all oars in the water" would be a more apt description,considering Vanguard's image fixation with British warships of theNapoleonic era. Bogle named the company after the British flagshipat the Battle of the Nile, and the firm's prospectuses and annualreports are filled with nautical illustrations.

Vanguard employees are known as the "crew," the company healthclub is the "ship-shape" room and the cafeteria is known as the"galley."

All this came about because Bogle happened upon a man sellingprints of English seascapes in 1975, when he was looking to name thecompany.

What many investors might not realize is that Vanguard, nowrecognized as the industry's low-cost leader, initially levied salescharges and didn't convert to a no-load format until 1977.

"But looking at the future of the mutual fund business, youquickly came to the conclusion that the place to be was the no-load,direct-market area," Bogle says. "Even back then, people werebecoming better educated about investments."

Today, Vanguard offers some of the lowest-cost funds anywhere.The Index Trust 500 Portfolio, for example, charges just 0.19 percenteach year, equal to $19 on a $10,000 investment. Performance, ofcourse, is reduced by whatever expenses a fund charges.

Vanguard is owned by its many mutual fund shareholders andessentially runs like a not-for-profit enterprise, with servicesprovided at cost. This explains why the firm's expenses onindividual funds are so low.

Vanguard also uses various other tactics to keep expenses down.For starters, its $3,000 minimum on taxable accounts is fairly highby industry standards and is one way to screen out smallershareholders, who are costly to service.

A few Vanguard funds impose much higher minimums, such as thethree Admiral bond portfolios, which require a $50,000 investment.

Also, Vanguard tacks transaction fees ranging up to 2 percenton certain funds to discourage short-term traders, also costly toservice. These aren't considered sales charges or loads because thefees collected are plowed back into the fund to defray trading andother costs. Still, they represent a real cost borne byshareholders.

It also helps that one in three Vanguard funds count more than$1 billion in assets - a higher proportion than at Fidelity, forexample. Larger funds enjoy economies of scale that often show up inlower per-share expenses.

If Vanguard has a weakness, it's a shortage of high-poweredstock funds of the caliber of, say, a Fidelity Magellan. The fournew Horizon funds have been touted as "Vanguard's answer toFidelity's dominance in the aggressive stock-picking sweepstakes,"writes Daniel Wiener, editor of the Independent Adviser for VanguardInvestors, an unaffiliated newsletter in Watertown, Mass.

It's worth noting that Morningstar Inc. of Chicago giveshigher ratings to Vanguard's bond funds than to its stock portfolios.

On Morningstar's five-point scale for measuring risk-adjustedperformance, with 1 the lowest score and 5 the highest, Vanguard'sstock funds average a 3.3 rating, while its bond products score a 4.2on average. Vanguard's hybrid funds, which hold both stocks andbonds, score 3.8.

Bogle says Vanguard's success can be explained partly by thetime and money spent training shareholder-service reps and other crewmembers.

In a customer-satisfaction survey released earlier this yearby Dalbar Inc. of Boston, Vanguard tied for eighth place out of 52banks, brokerages, insurers and fund companies examined.

Russ Wiles is a columnist and financial writer for the ArizonaRepublic.