Dear Beverly:My concern is that my wife has about $100,000 in (VWUSX) - Get Report Vanguard's U.S. Growth fund. It's one of the limited choices through her 401(k) plan, and neither one of us has been watching it very closely. I would expect volatility from this fund, but at what point do I start being concerned with management improprieties? It's beyond me how the fund cannot even match the S&P. The fund managers seem to be dancing as fast as they can. I was not aware until this morning that Alliance Capital was the adviser for the fund. It's my ignorance, but I'd assumed Vanguard would be the manager of its own fund. My question is should I suggest my wife dump this fund and cut our losses or will the volatility at some point start to work in our favor. Again, excuse my ignorance, but I thought that if anyone could be trusted to hold money for long-term investment it would be Mr. Bogle, but he seems to have turned his back on this one. Any advice would be greatly appreciated. Thanks, Daniel M.

Daniel,

There are several issues to tackle here, but the main distinction I want to make is between a poorly performing fund and one in which investors should worry about impropriety.

Vanguard's U.S. growth fund is a poorly performing fund. While it lagged its peers 2.5 percentage points in 2003, its immensely subpar performance has landed it in the bottom quartile of its category the four years prior -- which includes the bull market of 1999.

Alliance Capital

(AC) - Get Report

was brought on in June 2001 to replace longtime adviser Lincoln Capital, but the new team has largely avoided the more speculative stocks that drove the market up in 2003. While 28% of the fund is in technology stocks, contributing to the volatility of the fund, the bulk of that allocation is in blue-chips such as

Microsoft

(MSFT) - Get Report

,

Dell

(DELL) - Get Report

and

Cisco

(CSCO) - Get Report

, as well as biotechnology/pharmaceuticals companies such as

Pfizer

(PFE) - Get Report

and

Amgen

(AMGN) - Get Report

.

Last month, Alliance settled charges with the

Securities and Exchange Commission

and New York State Attorney General Eliot Spitzer that it defrauded mutual fund investors by allowing market-timing in a number of its funds. Morningstar analyst Christopher Traulsen says that the bad news about Alliance is mitigated for this fund's investors, since none of the managers of this particular fund have been accused of wrongdoing. More important, though, Vanguard -- not Alliance -- controls all the flows in and out of the fund.

Still, though, "it does raise some ethical questions about the people

Vanguard is doing business with," Traulsen says. "If I owned this fund I'd be looking for a replacement."

Fund companies frequently hire outside portfolio managers to do the buy-and-sell research and legwork. Each and every mutual fund has a board of directors -- 40% of those directors are supposed to be independent; the remainder can work for the investment management firm that oversees the fund. For instance, let's say this fund has 10 directors; four of them must be independent, and the other six can be Vanguard employees. It's the responsibility of the directors to hire the managers of the fund -- not just the individual, but also the firm. Management contracts should be drawn up to benefit the shareholders -- so minimizing costs is paramount. (Although not always -- for more on fee issues with subadvised funds, see

this story.)

The fund's directors will generally choose the least expensive management option -- and it's often cheaper to go outside the fund firm for portfolio managers. (Again, problems arise when the fund firm doesn't pass the savings onto investors.) When Vanguard, best known for its low-cost index funds, wanted to develop a line of actively managed funds, it was clearly more efficient to look outside the firm for the kind of expertise it wanted. It's not a matter of Vanguard founder John Bogle's "turning his back" on the fund (and it's worth noting that Bogle, now 74, stepped down as Vanguard's chairman four years ago). Rather, it's more a case of a highly volatile, concentrated, actively managed fund suffering in a bear market. It's a risky fund, and one that you probably don't need to be in.

Now, as to your disbelief in how the fund cannot even match the

S&P

, have I got news for you -- every year, 75% of all actively managed mutual funds fail to beat their index counterparts. Study after study has shown that index funds outperform 75% of actively managed funds over virtually any time period.

Still think the fund you pick will be the one in four that does beat the market? Consider this: Half of the funds that

do

outperform their relevant benchmark (not necessarily the S&P 500, a small-cap fund would use the Russell 2000, for instance, as its benchmark) do so

just as a matter of chance

. That's according to research done by Werner De Bondt, finance professor and chair of the Richard H. Driehaus Center in Behavioral Finance at Chicago's DePaul University. Those numbers are even more compelling since they don't include the thousands of failed funds that have either folded or merged over the years.

So now that leaves just 12.5% of actively managed funds beating their benchmark that might be attributable to skill. Sadly, though, it's not the same 12.5% that beat their benchmarks year after year. And the added fees charged for actively managed funds (although Vanguard's are unusually, and admirably, low) mean that it's even harder for fund investors to beat the benchmark. You mentioned that you haven't been watching this fund closely -- and that's not unusual. But if you're going to choose active management, you can't just "let it ride" the way you would an index fund.

There seems little reason to me for staying invested in this fund. If you're looking for a low-cost growth fund that will keep pace with the S&P 500, I'd suggest an S&P 500 index fund. Even 401(k) plans with limited choices almost always have one index option. If you're looking for a growth fund that's going to consistently beat the S&P 500 until your wife retires and starts making withdrawals from her 401(k) plan -- well, let me know in 10 years if you've found one.