The Vanguard Dog That Just Won’t Die

This has surely happened to you at some point in your experience as an investor: You buy a winning fund or stock that then falls on hard times. But you hold on to your investment as it drops further and further, convinced that it’s going to come back.

You’re in good company. Vanguard has stuck with a dog of a fund, Vanguard U.S. Growth (symbol VWUSX), through ten years of bumbling performance. And Vanguard is still singing the “it’ll come back” tune.

U.S. Growth delivered superior returns during the 1990s under the management of Lincoln Capital, which focused on large, high-quality growth companies. But Lincoln developed a taste for trendy tech stocks in early 2000, just as the tech bubble was about to pop. The fund’s picks headed south and so did its performance. Vanguard gave Lincoln the boot in mid 2001 and brought in AllianceBernstein as a replacement.

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You can’t really blame current management for the fund’s obscene 70% loss over the 2000–02 bear market -- after all, AllianceBernstein was mopping up someone else’s mess. But you can certainly hold the AllianceBernstein managers accountable for the bulk of the fund’s lackluster performance ever since -- the fund returned 4. 9% annualized from October 2002, the bottom of that bear market, through May t24, compared with the 6.4% annualized gain of Standard & Poor’s 500-stock index. In response to U.S. Growth’s mediocrity under AllianceBernstein, Vanguard brought in William Blair in 2004 to take over management of one-third of U.S. Growth’s assets.

But the fund still has its critics. “They’re terrible!” Dan Wiener, who writes the monthly The Independent Adviser for Vanguard Investors newsletter, says of the fund’s managers from AllianceBernstein. “Every year you think, Gee whiz, maybe this will be the year U.S. Growth shows a little gumption.” But every year “performance is lousy.” (In the nine years from the beginning of 1999 through 2007, the fund was in the bottom 30% of the large-company-growth category eight times.)

To U.S. Growth’s credit, it held up better than many during the recent bear market. Its 50% fall from the market’s peak in October 2007 through its bottom in March 2009 was better than the S&P 500’s 55% drop and was three percentage points less than the decline of its average peer. And the fund’s 0. 3% annualized loss over the past five years, which roughly matches the S&P 500, is more middling than condemning.

What’s more troubling is U.S. Growth’s performance compared with a similar AllianceBernstein fund. AllianceBernstein Large Cap Growth (APGAX) gained 2.9% annualized over the past five years. Yet the same team, led by Scott Wallace and James Reilly, uses the same style to run both the AllianceBernstein fund and the two-thirds of the Vanguard fund run by AB. Over the past three years, Vanguard U.S. Growth has lost 6.6% annualized, while AllianceBernstein Large Cap Growth has lost a comparatively benign 1.5% annualized. Although that difference could be Blair’s fault, Wiener, who regularly pores over the fund’s holdings and performance, swears that the Alliance slice is to blame for the fund’s woes.

Vanguard’s response is that the fund’s past performance is history and that shouldn’t prejudice investors against its future potential. “We’re continually reassessing the fund,” says Daniel Newhall, the head of Vanguard’s portfolio-review department, the group charged with assessing and selecting advisers for Vanguard funds. “We’re always asking ourselves, Do we think the team running the fund today gives us the best chance of delivering on shareholder expectations in the future?”

One would certainly hope Vanguard has confidence in its chosen management teams. After all, the firm funnels assets into U.S. Growth through two if its “funds of funds,” Vanguard STAR (VGSTX) and Vanguard Diversified Equity (VDEQX). Assets from those two funds account for roughly one-third of U.S. Growth’s $4.1 billion under management.

As if U.S. Growth didn’t already have enough baggage to bear, two of its key managers at AllianceBernstein, James Reilly and his brother Michael, will retire at the end of June. Newhall says Vanguard is reassessing its relationship with AllianceBernstein in light of their departures, but he won’t say whether the firm has reached a decision.

At this point, any change for the relatively few investors still holding on to U.S. Growth will be welcome. “If we had a marketing mind-set, the easy thing to do would be to erase this record” by liquidating the fund, Newhall says. But Vanguard is convinced -- honorably or stubbornly, depending on your point of view -- it can turn the fund around.