Vanguard Reopens Health Care Fund With High Entry Fee

Vanguard announced Friday that it is reopening its mammoth (VGHCX)Health Care fund to new investors, but only to those who can foot a new $10,000 minimum investment.

Vanguard closed the fund to let it "cool off" on Feb. 25 soon after it topped $10 billion in assets. (It has $11 billion now.) The nation's largest sector fund had just returned 40.8% in 1998, beating the S&P 500 by more than 12 percentage points, and money was pouring in -- $2.5 billion in 1998 and $564 million more in January 1999.

Vanguard feared too many performance-chasing, short-term investors were buying shares, ready to sell them at the first hiccup.

Growth Spurt The rise in Vanguard Health Care's assets has been steady and steep.
Year	Assets (billions)
YTD 1999	$11
1998	9.3
1997	4.5
1996	2
1995	1.5
1994	0.7
Source: Vanguard

During the closure, current investors could add only $25,000 to their accounts, and in April, Vanguard imposed a 1% redemption fee on shares held for less than five years.

Weak performance in the health care sector led to a $127 million net outflow in November, according to Dan Wiener, editor of the Independent Advisor for Vanguard Investors newsletter. Vanguard does not comment on cash flows.

Now that investors are less feverish, Vanguard says the fund, which has more than 430,000 shareholders, is ready to reopen.

"We believe that the extraordinary interest in the fund and the accompanying high cash inflows have waned sufficiently enough for us to resume offering the fund's shares to new investors," said Vanguard Chairman John Brennan in a prepared statement.

The firm is still concerned about short-term traders. Consequently, new investors will have to have long-term interest and, implicitly, bigger wallets. The fund's minimum initial investment will rise from $3,000 to $10,000 (the minimum for IRAs and Uniform Gifts to Minors Act accounts will still be $1,000). The redemption fee will stay in place, but the $25,000 additional investment limit will be lifted on current accounts when the fund reopens Dec. 20.

The higher minimum means modest investors will either have to find another health care fund or take a sizable position. A typical health care sector investment would make up 5% of a portfolio, according to Frank Armstrong, a financial planner with Managed Account Services in Miami. An investor would need a $200,000 portfolio to open an account at the new minimum without going over that 5% weighting.

Still, Armstrong says he understands the higher minimum and redemption fee given the fund's size and Vanguard's goal of low expenses. The fund's annual expense ratio is 0.36%, much lower than the 1.67% category average, according to Morningstar.

Interestingly, even though the fund is about three times the size of the next-largest health care fund, it hasn't sagged under the weight of its assets. Despite growing from $708 million in 1994 to $11 billion today, it's the top health care fund over the past five- and 10-year periods, according to Lipper, and only dips below the category average by 0.1% over the past year.

Healthy Returns Health care funds are lagging, but Vanguard's long-term record is still solid.
	YTD return	1-yr. return	5-yr. annualized return	10-yr. annualized return
(VGHCX)Vanguard Health Care	7.1%	12.4%	28.3%	21.9%
Lipper Health/Biotech Fund Avg.	6.7	12.5	20.3	18
S&P500	16	24.1	28.1	18
Data as of Dec. 2. Source: Lipper

Ed Owens has managed the fund since its 1984 inception, and the secret to his success has been a low-turnover style with a bias toward large-cap pharmaceuticals, according to Emily Hall, the analyst who covers the fund for Morningstar. Owens doesn't speak to the press for fear of drawing even more money.

Despite Owens' record, however, Hall says prospective investors should consider the fund's size before they invest.

"The fund is big. At some point, that's going to become a challenge. It's never going to be chock-full of small, biotech names because they aren't meaningful positions in a fund of this size. It's a caveat you have to be aware of," she says.

She adds that although there has never been mention of Owens leaving, investors should wonder if a successor could follow in his footsteps, especially given the suggested five-year holding period.

The fund's reopening is timed to follow its Dec. 16 distribution record date, so new investors won't buy shares only to be hit with a taxable capital-gains distribution.

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