One Board, 118 Funds: How Does That Work?

Besides running the nation's second-largest mutual fund company, Vanguard Group Chairman and Chief Executive John J. Brennan is chairman of each of the 118 Vanguard mutual funds. It sounds like a gargantuan job and an awesome responsibility since those funds have $690 billion and 17 million shareholder accounts. In this era of scrutiny of corporate governance, BusinessWeek -- and others -- questioned in their editorial pages how Brennan could serve investors' interests.

That riles Brennan because he takes his fiduciary role seriously. "You can do it if you're efficient," he says. Besides Brennan, there are six other directors, none of whom is a Vanguard employee. They meet 10 times a year for a day or two.

Key to making the system work is the 15-member Portfolio Review Group, which monitors fund performance and provides analysis to the board. This group also monitors the cash flowing in and out of the funds. Last June, for example, the group persuaded the board to close Vanguard High-Yield Corporate Fund to new investors for a three-month period to give portfolio managers time to put the enormous inflows to work and preserve the strong performance that attracted the money in the first place.

"It's a beautiful system," says Princeton University professor Burton G. Malkiel, a director for more than 25 years. "We have a staff that's monitoring what funds are doing -- are value funds still value funds? -- and how they're performing." Director Charles D. Ellis, a longtime pension fund consultant who joined the board in 2001, says the directors can be effective by addressing core issues such as compensation, performance, and expenses and not focusing on minutiae such as second-guessing a manager's stock picks.

Directors say this superboard approach saves money. Running 118 individual boards would be far costlier. Many issues -- such as redemption fees, compliance or investment management contracts -- are common to many funds, says Brennan, and having the same watchdogs makes more sense. While the board draws on the resources of Vanguard's compliance and legal staffs, Brennan also says board members are "encouraged to call any Vanguard employee for information that helps them make better decisions."

Critics say Vanguard's board is reaching too far. Daniel P. Wiener, editor of The Independent Adviser for Vanguard Investors, says governance would be more effective if boards were organized by the kinds of funds they oversee, such as index or money market. "There should be a focus on funds that have similar objectives," says Wiener.

Vanguard's governance model is not unusual. Rivals T. Rowe Price Group Inc. (TROW ) and Fidelity Investments have similar systems. Says Fidelity COO Robert L. Reynolds: "There's a tremendous efficiency and economies of scale by having a group of independent directors follow a number of funds managed by the same firm." To do otherwise, he adds, would be like Procter & Gamble Co. (PG ) having "a different board for every product."

Even though the Vanguard board has big responsibilities, it doesn't run up big bills. Directors were each paid $108,000 in 2002. (Putnam Investments Inc. (PEYAX ) directors have earned as much as $388,000.) At board meetings, lunch is platters of cold cuts. If a director wants a sandwich, he or she gets up and makes one. That's the Vanguard way.

By Lauren Young

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