What It Takes To Stay In The Vanguard

In the mutual-fund world, the "hot" fund is the one that leads the pack in performance and pulls in the cash. The Vanguard Index Trust 500 Portfolio, a mutual fund with a portfolio that duplicates the Standard & Poor's 500-stock index, is one hot property. During 1995, the fund's assets swelled 86%, to $17.3 billion. So far this year, investors have put in an astounding $2.1 billion. "I'm a little worried that the index fund is hot," admits John C. Bogle, Vanguard's chairman. "Hot is not our style."

Perhaps not. But index funds are in. They're cheap to operate, and they deliver the goods, which is Vanguard's style. And it explains why this company has made indexing a cornerstoneof its operation while most fund companies don't offer it. What's more, even those that do can't beat the Vanguard's S&P-500 rock-bottom expense ratio of 0.19%. In contrast, expenses at Fidelity's and T. Rowe Price's index funds run 0.45%, and at Dreyfus, they are 0.61%.

CAREFUL INVESTING. Low expenses give the index funds a headstart over actively managed mutual funds. Last year, the average equity fund incurred expenses of 1.28%. That means other fund managers have to take bigger risks to earn over 1% more just to stay even with the Vanguard 500. George U. "Gus" Sauter, the fund's manager, has a less daunting task: He has to make sure the fund is investing its money in the correct proportions so that it tracks the index.

Vanguard launched the first index mutual fund in 1976 with only $11 million in shareholder money. But in the 1980s, investors discovered the S&P fund, and by 1987, the fund hit $1 billion. "That's when I knew we were a success," says Bogle. That's also when Sauter, a University of Chicago MBA, came on board to run the fund and develop other indexed equity products.

Vanguard currently offers 17 equity and 6 bond index funds, and all index-fund assets total $42 billion. For investors who want small company stocks, the Small Capitalization Stock Portfolio tracks the Russell 2000 index. Vanguard's Extended Market Portfolio covers smaller stocks as well, starting where the S&P 500 leaves off and picking up the other stocks that make up the Wilshire 5000. The Total Stock Market Index covers the entire Wilshire universe--large- and small-cap stocks.

All of those funds are enjoying growth spurts, too, as are the international index funds: European, Pacific, and Emerging Markets. A new fund will soon tie those three into one international index. Also in the works is an index fund that invests in real estate investment trusts.

In pushing beyond the S&P, Sauter is challenging the conventional wisdom that active managers can exploit inefficiencies in smaller-cap stocks and foreign markets that don't exist among the U.S. blue chips. "Perhaps so," says Sauter, "but can they flesh those inefficiencies out in a cost-effective way?" In less liquid foreign markets, he notes, the high management and trading costs chew up those profits, leaving index funds--which have no active management and do little trading--with a distinct advantage. From 1991 to 1995, for instance, Vanguard's European index fund beat 80% of its competitors. Last year, the new emerging-markets index fund bested nearly two-thirds of its peers.

It's a bit too soon to tell whether or not Vanguard's newer index funds will match the success of its flagship. But so far, they're off to a mighty good start.

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