When a mutual fund with a stellar record, clear plan, and experienced manager has a few deeply disappointing years, investors and fund trustees alike must ask themselves some hard questions. Do you dump the fund or, if you're a trustee, fire the manager? Do you keep reciting the mantra, "invest for the long term"? Or do you move part of your money to another fund? "It's no different for a trustee...than it is for an individual," says Vanguard CEO John Brennan. "They have to make the same kind of judgments."
Trustees of Vanguard Group, responsible for overseeing 102 funds, faced this conundrum in March as they wrestled with what to do about the group's $16.5 billion Windsor Fund. From 1964 to 1995, under value-stock picker John Neff, Windsor shined with hearty bets on equities the world hated--Citicorp in 1990, for one. Neff was a partner at Wellington Management, an independent firm Vanguard hired to run Windsor. When he retired, his longtime deputy at Wellington, Chuck Freeman, stepped in. But under Freeman, Windsor has sunk to the lowest quintile among mid-cap value funds, according to Morningstar. As a result, Vanguard will shift some Windsor assets by June 1 to Sanford C. Bernstein, another outside manager that favors a more widely diversified approach to value-stock investing than Freeman's. Freeman, who will retain at least half of the assets, says, "I regard them as kindred spirits."
Vanguard's decision may or may not prove right, but a look at the process the firm pursued in making its move helps to outline the issues anyone with a doggy fund should mull. Here are four questions to ask yourself:
-- Why did I buy this? A fund should get you to your goal, without any more risk than necessary. If you bought a foreign-stock fund to diversify your domestic exposure, don't worry if it has paled next to U.S. stock funds. But make sure your goal hasn't changed. Windsor has a long history of ugly spells--a result of Neff and Freeman's habit of taking big stakes in a few stocks. Brennan says that's a risk Vanguard, in balancing demands from many fund holders, no longer wants.
-- Is the fund acting as advertised? If your laggard fund's behavior is in line with that of comparable funds, no problem. But you should worry if it's acting out of character--a sign the manager may have changed strategies. "The way we lose confidence in a manager is for him to decide things have changed," Brennan says. Had Freeman dropped his contrarian style, buying, say, Microsoft shares and rationalizing its high price-earnings ratio, Brennan suggests Vanguard might have taken away all of Windsor's money, not just some.
-- Am I crazy? Too many investments are made emotionally, especially amid the pain of losses. Charles Schwab senior portfolio manager Cynthia Liu suggests giving a fund one full cycle to show its stuff. If its style is to trade a third of its portfolio each year, give it three years before selling out. And use a spouse or trusted confidant as a sounding board. Windsor trustees held wide talks for months with in-house experts before reducing Freeman's role.
-- What choice do I have? It's one thing to sell a fund because it's hurting. It's another to find an alternative. Spotting the best fund can be maddeningly difficult. In Windsor's case, Vanguard hedged its bets. With most of Windsor's assets staying in Freeman's "deep-value" picks, investors can hope for a payoff someday. In the meantime, Windsor's added second manager lowers its risk.
Next time you buy a fund, "spend a lot more time looking at the risks," says James Jornlin, a senior investment officer at pension-fund consultant Frank Russell. Sell? Hold on? Hedge? No simple answers, just questions to tackle.