Vanguard Gets An Earful
Critics and customers fear the firm has lost some of its idealism
When it comes to simple investing for the small investor, there's no easier choice than Vanguard.
After all, the Valley Forge, Pa., mutual fund company was founded by John C. Bogle, who is sometimes called "Saint Jack" for his outspoken views and selfless assistance to small investors. Analysts at the fund tracker Morningstar recommend more Vanguard funds than any other. And Vanguard wins praise--as well as the personal savings--of such investor champions as former Securities and Exchange Commission Chairman Arthur Levitt; Mercer Bullard, founder of Fund Democracy; and Barbara Roper, financial services expert at the Consumer Federation of America. "Vanguard has a culture of integrity and low fees," says Levitt. "And I recommend low-expense-ratio index funds. If I preach it, I ought to practice it."
With those kinds of endorsements, it's no wonder that fed-up investors have been stampeding to Vanguard since the bear market and last fall's industry scandals. So far this year, Vanguard has taken in nearly $24 billion in new money--more than 2 1/2 times the amount it reaped in the same period last year and an all-time high for Vanguard. "For now, at least, the good guys are winning," says Jaime Punishill, a fund industry analyst at Forrester Research.
But can that continue? Some of Vanguard's biggest fans are starting to worry that the nation's only truly mutual fund company--Vanguard redistributes profits back to individual fund holders through lower expenses--may not be able to maintain both its growth and its ideals.
Morningstar research director Russel Kinnel still favors Vanguard, saying it "is doing a great job. They are still one of the best values. I still have money in Vanguard." But he has noticed "big changes in the company's approach."
Vanguard is clearly feeling growth pains. The influx of new customers has overwhelmed its staff. The average time a caller to Vanguard spends on hold has more than doubled to nearly four minutes since last year. That dropped Vanguard two slots to eighth out of the 10 biggest fund companies, according to the most recent ranking of telephone service by Dalbar Inc. Vanguard's Web site is also showing strains, freezing up or crashing during transactions, some customers say. In a complaint filed with the Securities and Exchange Commission and other regulators in December, an ex-employee has described a dysfunctional and chronically understaffed customer service department that can't help but give short shrift to small investors as it tries to meet orders to cultivate wealthy clients. "Vanguard tries so hard to get costs down, and has kept staff levels so low, that service levels are suffering," says Doris "Dee Dee" Havens, who says she was fired from a Scottsdale, Ariz., call center in February after trying to E-mail her complaint to coworkers.
Vanguard says the recent service snafus are just temporary and already being addressed. The company has marshaled its "Swiss army" of executives--from chairman John Brennan on down--who take shifts on the phones while hundreds of new employees are being trained to handle the 1 million new accounts opened in the past year.
Makeover. That will help, but Daniel Wiener, editor of the Independent Adviser for Vanguard Investors , who worked for U.S. News from 1987 to 1991, warns customers not to expect too much improvement. "Vanguard says you can pay less and still get the best service, but that's not true," he says. "They've got to be saving money somewhere, and some of the places they save it is in hiring, salaries, and the Web."
More troubling to customers and fans, however, are subtle changes in policy and style that seem to conflict with the idealism and no-nonsense investing style of Bogle. Vanguard's founder hasn't had a management role since his forced retirement in 1996, but he continues to preach his investing gospel at congressional hearings, press conferences, and industry get-togethers.
But Bogle's handpicked successors have fought many of the reforms Bogle has championed recently. Last year, Brennan opposed a Bogle-backed initiative to force fund firms to tell shareholders how they vote on their behalf on such matters as directors and fees paid to outsiders. The SEC eventually enacted the proposal over the industry's objections. Brennan is currently fighting attempts to require Vanguard to reveal his and other executives' compensation, as well as proposals that would require him to step down as chairman from all of the boards of Vanguard funds.
That bothers customers like Levitt, who says "on governance issues, I am solidly with Bogle," and the CFA's Roper. "I do see a difference in tone," she says. "Stylistic changes make you worry about substance changes."
Investor friendly. Noting that Vanguard already publishes the rules by which it votes proxies and that its fund boards are dominated by independent directors, Vanguard officials insist they oppose rules that would unnecessarily add costs and thus cut investors' returns. "We're always on the side of the investor," says Brennan. "Whether it's a popular [stance] is a whole different issue. We know in our bones what's right for investors."
Some knowledgeable observers are worried that Vanguard may be veering from the boring but successful indexing strategy that Bogle and Vanguard board member Burton Malkiel made famous. Malkiel, a Princeton economist, has shown that an index fund made up of stocks of every public company in America outearns the vast majority of funds run by active managers. And Bogle's main claim to fame was putting together what were the first--and are still the cheapest--index funds.
But Brennan recently launched several new sector funds to augment those started by Bogle in the 1980s--much to Bogle's dismay. "Sector funds are losers for investors," says Bogle, who is careful not to criticize current management. "I made the awful mistake of starting a bunch of sector funds in 1985, and I am man enough to admit my mistake."
What's more, customers who ask Vanguard for a financial plan today are usually told to put only about half of their cash in index funds. The other half is directed to actively managed funds. That confounds indexing fans like money manager Roy Weitz, founder of FundAlarm.com: "You used to be able to put your guard down with the old Vanguard. But they are turning into just another big financial services firm, and now you have to protect yourself, even from them."
Catherine Gordon, who heads the Vanguard research group that develops the planners' recommendations, says managed funds buffer investors from downturns. For his part, Malkiel advises people to put a higher percentage of their money in indexes and just "do a little active around the edges." But he says he's happy Vanguard promotes even a 50 percent allocation to indexes, since that is more than triple the average investor's stake. He vehemently denies that Vanguard is straying from its core values. "I am absolutely convinced there has been no divergence from the wonderful ideals that Jack Bogle set up," he says.
And to the extent that Vanguard is changing, even its toughest critics admit the company has lost little of its aura. Despite her firing, ex-employee Havens still thinks Vanguard is better than the competition. "My friends ask me: `So what do we do with our money?' The problem is that I don't know anybody who is doing a better job."
This story appears in the May 3, 2004 print edition of U.S. News & World Report.