Vanguard Not Rushing to Judge AXA Rosenberg

Several institutional and retail investment firms have already made up their minds about AXA Rosenberg, the quant shop that last month revealed a coding glitch in the models it uses to build portfolios; the glitch was first discovered nearly a year ago. Vanguard, for whom AXA subadvises a little more than $1 billion, is not among them.

Consultants have urged clients to fire AXA Rosenberg. Pension funds in Los Angeles and Fresno, Calif., have taken the advice. Even  Charles Schwab (SCHW) last week decided to fold its four Laudus Rosenberg funds that AXA Rosenberg subadvises. I recently spoke with Dan Newhall, the head of Vanguard's portfolio review department, which evaluates, selects, and monitors the family's nearly 30 subadvisors, to get his read on the situation. Based on that conversation, it's clear that Vanguard is vigorously reviewing its relationship with AXA Rosenberg but not rushing to judgment. "Those who have already acted arguably have not gathered all of the information," Newhall said.

Vanguard has no immediate plans to replace AXA as a subadvisor on  Vanguard U.S. Value ,  Vanguard Explorer (VEXPX), and  Vanguard Market Neutral (VMNFX), though that could change if a review under way by AXA turns up any more bad news, Newhall said. "We're going through a process right now of trying to understand the circumstances around this issue," he said.

That process has included sending a team of analysts to the subadvisor's Orinda, Calif., offices and bringing the firm's senior investment professionals to Vanguard's Malvern, Pa., headquarters. Vanguard also has dug into the funds' performances and portfolios for signs that the error affected results. AXA Rosenberg has told Vanguard that the mistake, which existed before the 2007 start of the firms' partnership, did not affect Vanguard Market Neutral, Newhall said. So far, however, it has been difficult to determine if the fault hurt U.S. Value and Explorer. "There were very few signs that anything was out of line with expectations," Newhall said.

In the nearly three years that AXA Rosenberg has managed about half of U.S. Value, the fund has lagged its large-value category peers and its Russell 3000 Value benchmark. Market Neutral also has struggled to clear its hurdle of U.S. Treasury bills, but Explorer, where AXA Rosenberg is one of seven subadvisors, has been a steady performer. That's not a sterling record, but it did coincide with a difficult three-year period for quantitative investing, Newhall said. It's not unusual for investing approaches to face cyclical headwinds, he said. "We've seen this before in other styles." Still, it's impossible to tell how AXA Rosenberg has done on these funds because it's just one of two-to-seven subadvisors and Vanguard doesn't break out the results of individual firms for its multimanager funds.

Vanguard's forbearance is not infinite, though. At the very least the family hopes to see better communication between AXA Rosenberg's research center and its global portfolio management team, Newhall said. But Vanguard won't act until it has all the facts and figures. "We are monitoring every new piece of information," said Newhall, who also is giving regular updates to the fund's board of directors and the family's senior managers.

Newhall isn't worried about AXA Rosenberg's viability. Even considering the business it has lost, the firm still has more than $60 billion under management in hundreds of accounts across the globe, he said.

Vanguard's reaction to the AXA Rosenberg's revelation is consistent with its process for selecting, monitoring, and evaluating subadvisors. Morningstar hasn't always agreed with the way the family has managed its subadvisors, but no one could ever accuse Vanguard of being hasty. Furthermore, AXA Rosenberg is not the sole subadvisor of any Vanguard fund, so even if the firm's coding error did impinge on performance, the diversity of managers probably lessened the ultimate effect. The challenge will be in determining if this episode has hampered AXA Rosenberg's ability to succeed in the future. The jury is still out on that question.

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