First of two parts
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 at a time when investors are moving assets to low-cost index funds.
"It has been a tumultuous period, but Vanguard is coming out of this ahead," said F. William McNabb 3rd, who became the company's president and chief executive in August. "It illustrates the power of diversification, and that is a very important point. I know it must sound like motherhood and apple pie, and it sounds pretty basic, but competitors lost sight of it. They lost sight of it in the late 1990s and they lost sight of it recently. Our success comes down to remaining disciplined."
Calling the current environment "Vanguard weather," Mr. McNabb said the firm has added customers in the past four months and is now the largest U.S. fund company. Vanguard stole that title from Fidelity Investments this year. Vanguard, based outside Philadelphia, in Malvern, Pa., had $1.072 trillion of assets under management as of Nov. 30 and Fidelity, of Boston, had $1.069 trillion, according to Lipper, a unit of Reuters.
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 Mr. McNabb said he received a ton of letters from investors.
Mr. McNabb, who has worked at Vanguard for 22 years, said in an interview last week that he was surprised that the letters weren't hate mail — the company's investors wanted clarity about market conditions.
Tim Buckley, the 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. He said 80% to 90% of Vanguard's retail customers maintained their investment strategy.
"We have seen a huge amount of buying activity," Mr. 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 Mr. 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 say that Mr. McNabb's 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, the president of Bobroff Consulting in East Greenwich, R.I. "If the company doesn't, then investors are going to take their money elsewhere. 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 in the fund industry that had heavy outflows and have been forced to cut staff and expenses over the past couple months, Vanguard has had its second-best year, generating $75 billion of net inflows through November, according to Mr. 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 next quarter, on top of the 1,300 it cut in November, Vanguard has not cut jobs.
Mr. McNabb said that Vanguard was 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."
Mr. 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," Mr. 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 Web site," he said. "It happens by having good people that are in place for a long time. … Institutional loyalty creates client loyalty."
Mr. Bobroff said he does not think Vanguard can completely avoid job cuts. "Vanguard has been and will be able to weather the storm longer than their competitors, but if this is a prolonged economic downturn, I would daresay that cuts will be required at Vanguard too," he said.
Mr. McNabb said there are ways to reduce expenses without cutting jobs. Vanguard has "decent natural turnover" and can adjust its hiring to market conditions, he said.
Mr. Buckley said Vanguard will take a hard look at the projects and products that it invests in. "This is a bigger downturn than anyone expected, but it doesn't change our primary approach," he said. "Our primary competition hasn't changed. They are facing challenges just like we are. We are going to have to be disciplined about how we deploy our resources, and in times like this we'll tighten our belts, but we are going to be intelligent about how we do that."
He added, "We haven't been in the news for making job cuts, but that doesn't mean that we won't tighten our belts."
Mr. McNabb said he does not want Vanguard to spend 2009 focused only on cutting expenses.
He said he wants to find ways to take advantage of market conditions to foster growth. This means spending on things like technology and product development.
He said he expects further consolidation in the fund industry, and said Vanguard will be opportunistic. This does not mean it will look to acquire, because that has never been part of the strategy for the 33-year-old company, but Mr. McNabb said it hopes to attract customers as competitors consolidate. "A lot of firms grew very rapidly in terms of staffing and budget, so it isn't shocking to see that they are going through cuts," he said. "Honestly, it is hard to figure out how they got so big."
Vanguard invested in different businesses over the past decade, includng technology, and Mr. McNabb said he is now "taking a hard look" at such projects. "We invest in a lot of new stuff every year," he said. "We are aggressive that way. We invest in technology and we think that it has really benefitted our clients, but we can slow that down if we need to."
Mr. McNabb said he expects strong net inflows in 2009, at least matching the $75 billion it generated through November.
Analysts said it could be difficult; most expect assets managed by U.S. mutual fund companies to continue to decline next year.
Mr. McNabb said he thinks that individual and institutional investors will spend less and save more next year.
"The silver lining in this crisis is that there has been a reduction in consumption and a return to savings," he said. "It won't necessarily help the economy in the short run, but it will help things in the long term if we are able to break out of this period of overconsumption and transition to a period where savings are held in high esteem. That is certainly a positive thing long-term for our society in general."
Coming tomorrow: A closer look at Vanguard's strategy for next year and opportunities Mr. McNabb and his top lieutenants see for growth in exchange-traded funds, target-date funds, and its retail business.