Vanguard Reins in Hot Fund while a New One Cools Its Heels

Vanguard has taken steps to tone down its hottest performing fund and laid plans to launch a new actively managed domestic small-cap value fund. The family also announced some routine manager changes to  Vanguard International Growth (VWIGX) and  Vanguard International Value (VTRIX).

Vanguard has added a manager to  Vanguard Capital Value , which has gained more than 80% this year and has been among the best performing domestic stock funds of 2009. David Palmer will join Peter Higgins, who has run the fund since June 2008. Both Palmer and Higgins work for subadvisor Wellington Capital Management but will run separate sleeves of the fund independently and in different styles.

Back to the Future
Ironically, Palmer is a member of the Radnor, Pa.-based team whose members still run most of  Vanguard Windsor (VWNDX) and used to run Capital Value until the Boston-based Higgins took over at Vanguard's request. Palmer has been listed as a manager of the Wellington subadvised Hartford Value Opportunities  for nearly seven years with former Capital Value and Windsor manager David Fassnacht, and current Windsor manager James Mordy.

Vanguard, which closed Capital Value to new investors for a "cooling off" period in October, made the change to moderate the fund's volatility. While Capital Value always has been an opportunistic and aggressive fund, it has been a high-octane vehicle since Higgins arrived. He's an eclectic contrarian who's not afraid to lay wagers on deeply out-of-favor stocks and even more growth-oriented companies. He trades frequently. The fund's turnover has jumped from 56% in 2007 to 300% recently.

The Radnor team is opportunistic and contrarian, too, but practices a lower-turnover, more classic value approach in the vein of former Windsor manager John Neff, who worked out of the Radnor office with many of the current team members. The Hartford fund they run had some rough years in 2007 and 2008, losing nearly 7% and 42%, respectively, but the team's long-term record there is respectable. In Palmer's tenure as a listed manager, the fund has gained 2.7% annualized through Dec. 21, 2009, and beaten the typical large-value fund and Russell 1000 Value Index. The fund has not been a low risk fund, but its standard deviation of returns is lower than that of Capital Value.

Where the Wild Things Aren't
Vanguard CEO Bill McNabb hinted that this change was coming in a recent interview with Morningstar. When asked earlier this month why Vanguard took steps to rein in the volatility of  Vanguard Growth Equity  by replacing Turner Investment Partners while handing Capital Value to a manager with an aggressive volatile style, McNabb said, "You should probably expect us to try to figure out how to address that before we reopen the fund."

Ultimately Vanguard would rather not offer feast or famine funds that might attract deluges of money went they're hot and suffer exoduses when they are not, McNabb said. While touting such funds can be attractive in the short run, "it's an absolutely stupid strategy in the long run, because you're going to disappoint people," he said.

New Kid in Town
Vanguard's new fund will be called Vanguard Explorer Value. It will focus on small- and mid-cap value stocks and should be available early in 2010. Three subadvisors--Frontier Capital Management, Cardinal Capital Management, and Sterling Capital Management--will each manage a third of the portfolio to start. The fund will have an expense ratio of 0.56%, which puts it in the bottom quintile of fees for no load small-cap funds.

Frontier Capital Management, which has $6 billion in assets, has run a slice of  Vanguard Morgan Growth  since 2008. Cardinal and Sterling are new to Vanguard. Sterling, which has about $12 billion under management, has run BB&T Mid Cap Value (OVEAX) for at least five years and has a strong record in the mid-cap value category. Cardinal, which has about $1 billion under management, has run Brown Advisory Small Cap Value  since its 2003 inception and has finished three of the last six years in the top half of the small-blend category.

The managers will be Thomas Duncan and William Teichner of Frontier; Amy Minella, Eugene Fox, and Robert Kirkpatrick of Cardinal; and Eduardo Brea and Brian Walton of Sterling. All the managers appear to use fundamental analysis to find stocks trading at discounts to their cash flow or intrinsic values, according to the prospectus.

As is standard for Vanguard, the subadvisors will get a base management fee, plus a performance adjustment based on trailing three-year performance versus a benchmark, usually the Russell 2000 or Russell 2500.

Housekeeping
The management changes at International Growth and International Value appear minor. At Growth Simon Webber replaces Matthew Dobbs as portfolio manager for Schroder's portion of the fund, working along with long-time manager Virginie Maisonneuve. At Value, Christine Montgomery has left Edinburgh Partners, leaving Sandy Nairn the sole manager for the firm's portion of the fund. All the other subadvisors at the funds remain unchanged.

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