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Vanguard Weathers Storm Under New CEO

Most executives wouldn't consider themselves "fortunate" if they took over one of the largest fund companies weeks before an historic market collapse.

But then, most executives aren't taking over Vanguard Group in a time when investors are stampeding assets to low-cost, passive index funds.

"It has been a tumultuous period, but Vanguard is coming out of this ahead," said F. William McNabb III, who became the company's president and chief executive in August. "It illustrates the power of diversification. I know it must sound like motherhood and apple pie, and it sounds pretty basic, but competitors lost sight of it in the late 1990s and recently. Our success comes down to remaining disciplined."

Calling the current environment "Vanguard weather," McNabb said the firm has added customers in the past four months and is now the largest U.S. fund company, barely stealing that title from Fidelity Investments with $1.072 trillion of assets under management, compared to Fidelity's $1.069 trillion, according to Lipper.

In the first week of October, when the Dow Jones Industrial Average sank below 10,000, Vanguard's daily call volumes spiked to 80,000 from 35,000, online logins rose to 570,000 from 350,000, and McNabb personally received a ton of letters from investors.

McNabb was surprised that the letters weren't hate mail; instead investors turned to Vanguard as a trusted source for clarity about market conditions.

Tim Buckley, managing director of Vanguard's retail investor group, said during the tumultuous period from September to October, Vanguard's sales leads increased, the number of new accounts rose, and buys outnumbered sells 2 to 1 in its brokerage business. Importantly, 80% to 90% of Vanguard's retail customers maintained their investment strategy.

"We have seen a huge amount of buying activity," Buckley said. "I mean, it's not off the charts, but it was amazing to see activity as the markets struggled. It was reassuring that customers either didn't do anything or their investment behavior was positive."

This type of behavior has made McNabb confident about how his company will perform during the rest of the recession. "I am very fortunate to come to Vanguard now," he said. "A lot of hard work was done by my predecessors. They established a culture here where managers know that no one - all the way up to the board of directors - is going to pressure them to do anything investment-wise that they don't think is prudent."

In fact, those predecessors cast long shadows - John J. Brennan and John C. Bogle - and analysts said McNabb's own legacy will be forged by how he steers Vanguard past the current crisis.

"Vanguard needs to consider if it has the right investment products in place for when this downturn ends," said Geoffrey Bobroff, president of Bobroff Consulting in East Greenwich, R.I. "The real measure for Vanguard isn't how they perform now, but if they can maintain these assets when markets bounce back."

Unlike some of its competitors that have had heavy outflows and have been forced to cut staff and expenses, 2008 was Vanguard's second-best year, generating $75 billion of net inflows through November, according to Buckley. (Last year it had $110 billion of net inflows.)

And while Fidelity plans to cut about 1,700 more jobs by the end of the first quarter, on top of the 1,300 it cut in November, Vanguard has not cut jobs.

McNabb said that Vanguard has been able to sidestep some of the problems that have hampered its rivals by remaining conservative with its money market funds during the summer as "half a dozen or more" other fund companies delivered higher yields.

"We were moving to a more conservative posture, and we were completely confident with that decision," the CEO said. "Preservation of capital was our No. 1 priority with our money market funds."

McNabb predicted Vanguard will not need to make drastic expense reductions next year. Rather, it will look for ways to capitalize on some of the disruptions in the market to expand its businesses.

"I will never say never, but it would be a failure on my part not to keep this place in good enough shape to avoid any dramatic job cuts," he said.

Analysts said that Vanguard's cost-consciousness has helped it stay ahead of rivals like Fidelity and American Century. "We have always tried to run ourselves leanly," McNabb said. "We have carefully tracked our expenses, even when times were good. Jack [Brennan] built a culture of financial discipline here."

"Client loyalty doesn't just happen because of great performance or low-cost funds or a cool website," he said. "It happens by having good people who are in place for a long time. Institutional loyalty creates client loyalty."