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Divvying Up Windsor Fund Portfolio Is No Simple Task

Vanguard must manage the transfer of more than $4 billion to new co-manager Sanford C. Bernstein.

Dividing up the assets of a mutual fund is a bit like trying to share an ice cream cone. There's really no neat way to do it.

At least that seems to be the case for

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Vanguard Windsor fund.

The Vanguard Group

announced in March it would hand a portion of the fund's $18.4 billion in assets to New York-based

Sanford C. Bernstein

after deciding that manager Chuck Freeman of

Wellington Management

could use some help running the portfolio.

Now Vanguard says Bernstein's portion of Windsor will amount to 25% to 33% of its assets. Bernstein assumed co-management responsibility on June 1. Vanguard won't reveal exactly how it is transferring those assets other than to say the process is ongoing.

Splitting the fund's assets is not as simple as cutting a check for $4.6 billion to $6.1 billion and sending it Bernstein's way. First, Vanguard needs to raise the cash.

Since Bernstein's mandate is to add diversification to the Windsor portfolio, that suggests Freeman has to sell -- or has sold -- a significant portion of the fund's assets.

John Demming, a spokesman for Valley Forge, Pa.-based Vanguard says selling stocks is among Freeman's options. But he says there's another possibility as well.

"We can direct future positive cash flow to Bernstein," Demming says.

That's an unlikely scenario for raising the billions earmarked for the new managers, though. Vanguard Windsor had net outflows of $2.6 billion in 1998, according to

Financial Research Corp.

And this year, the fund bled $1.9 billion through the end of April, FRC estimates.

But Demming says since the fund reopened to new investors last week, there has been "positive" interest in it, though he wouldn't say whether that means positive inflows.

If Freeman has been selling stocks to raise cash to hand over to Bernstein, those sales could result in increased capital gains for Windsor shareholders. For instance, at the end of February -- before Vanguard announced its decision to bring in Bernstein -- the fund had realized capital gains of 68 cents per share, or 4.5% of its net asset value at the time. By the end of May, after the fund had started making preparations to give Bernstein its percentage of assets, the gain had increased to 90 cents per share, or 5% of net asset value.

"It's a modest uptick," Demming concedes, pointing out that those gains could be less or more when the fund distributes them in December. To minimize the realized gains, Freeman has the option of selling stocks that have depreciated or haven't changed in price since he bought them, he says.

Splitting up a portfolio is nothing new for Vanguard. It farmed out a portion of its Windsor II fund to Invesco in 1987 to help with capacity after the fund took in $1.6 billion in two years. The fund now has three separate sub-advisors, led by Jim Barrow at

Barrow, Hanley, Mewhinney & Strauss

in Dallas. Other funds at Vanguard that have multiple subadvisors are

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At Bernstein, Marilyn Fedak and Steven Pisarkiewicz will manage the firm's portion of Windsor's billions.

While Vanguard is by no means alone in farming out its assets to subadvisors -- some companies outsource 100% of their assets -- it does so on an unparalleled scale. Vanguard outsourced the most cash of any mutual fund firm in 1998, letting subadvisors run $146 billion of its $485 billion in assets, says analyst Ray Liberatore at Financial Research Corp. The second-largest outsourcer was


, with a relatively small amount of $22 billion.

For Windsor, handing over assets to Bernstein effectively creates two portfolios run by independent management teams. That could result in some overlap in its stocks.

"With Wellington and Bernstein you have two of the best value managers on the planet," Demming says. "So they may own some of the same companies."

Taking the charitable view, that overlap may not be extreme. Jeffrey S. Molitor, director of portfolio review at Vanguard, told

in April that Bernstein picked few of the same stocks for a model portfolio of the fund.


Freeman and his team had a portfolio of about 100 names and Bernstein ended up coming up with a portfolio of 100 names," Molitor said. "But there were only 14 overlaps. So there you go. There's the diversification."

Vanguard had been

reluctant to disclose just how much of Windsor's billions would go to Bernstein.

"We did not want the Street to front-run the fund," says Demming. "That would have been detrimental to the shareholders."

But to take the not-so-charitable view, revealing how much money Bernstein gets might tell investors something else: how much confidence Vanguard has left in Freeman. Demming discounts that suggestion as ludicrous.

"The flat answer is we are 100% behind Chuck Freeman and his team," Demming says.

Freeman became assistant manager of the fund in 1974 and has been sole manager since 1996. Its returns had been lagging from 1997 until the recent comeback of value stocks. This year, Windsor is returning 17.5%, handily outpacing the 9.2% return of the

S&P 500