Vanguard's Investment Cop Keeps a Lookout for Style Drift

Jeffrey Molitor makes sure investors get the kind of fund they signed up for.
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MALVERN, Pa. -- The squeaky-clean image of the

Vanguard Group

belongs to

Jack Bogle

, its founding father. Over the years, his tireless battle within the industry for lower-cost funds has garnered the giant a sparkling reputation.

It's

Jeffrey Molitor's

job to keep that reputation polished.

As director of portfolio review, he makes sure Vanguard's 20 actively managed funds, which are farmed out to independent asset managers, consist of the stuff investors bought into in the first place. Perhaps more than anyone else at Vanguard, he's responsible for making sure the company's shareholders don't find any nasty surprises in their funds.

"We're sort of the red-flag patrol," says Molitor, sitting in his office at Vanguard's sprawling campus outside Philadelphia. "We're an extra set of eyes and ears for our shareholders."

In other words, Molitor is Vanguard's top investment cop, commanding a team of 12 portfolio sleuths.

Like

Javert

tracking

Jean Valjean

, Molitor keeps a constant eye on the portfolio moves of Vanguard's active managers, looking for any signs of a slip in consistency. That might mean some larger companies inching into a small-cap fund, or some suspiciously growth-like names slipping into a value portfolio.

What he's worried about is style drift. Because no one can predict which parts of the market will outperform, Molitor says, the only thing investors can be sure of when they buy a fund is the amount of risk they are buying into. Because risk is inherently related to style, Molitor wants to make sure shareholders are only exposed to the risk they wanted in the first place.

Shareholders "know they can't predict returns, so they're buying a basket of risk," Molitor says. "They can't bet on anything else. We're there to make sure that the portfolios are delivering on that."

Jovial and clear-eyed, Molitor, 46, obviously enjoys his job. Once a forecaster for

Standard Oil

, he soon shied away from the task of trying to predict the future and instead took a job managing its pension investments. He came to Vanguard in 1987, he'll tell you with a sardonic grin, two weeks before the October crash.

On one wall of his office is a huge cardboard placard detailing the layout of the Vanguard offices on the floor where Molitor works. A legend denotes a blue-shaded area -- well over 90% of the board -- as the "Holy Molitor Empire." Next to that is a cutout of Molitor's head, pasted onto

Napoleon Bonaparte's

body.

The placard is the result of a small internal skirmish over office space a few years ago. But considering Molitor's role at Vanguard, it seems on target in describing his job.

"I'd say he's respectfully emphatic. He isn't in any way defensive -- or apologetic," says Ian MacKinnon, who oversees Vanguard's fixed-income funds. Molitor likes to "tear down" a manager's portfolio, he says, before building it back up to find the meaningful bets.

So where does a style detective look when trying to determine if things have gone awry in a portfolio? Like an investor, Molitor starts with performance, because that's usually the first hint something is out of sorts. Other clues might be a manager frequently getting in and out of the same stock or wavering between a bullish and bearish stance.

Ironically, one of the first clues is that a fund is blowing the doors off its peers. If it's a value fund, that might mean the portfolio has some growth elements charging up its returns. On the other hand, a growth fund that's sagging might not be taking on the amount of risk that investors signed up for.

It was Molitor who, in March, brought in Marilyn Fedak and Steven Pisarkiewicz of New York-based

Sanford C. Bernstein

to help with the beleaguered

(VWNDX) - Get Report

Windsor fund.

Until March, the portfolio was piloted solo by Chuck Freeman of Boston-based

Wellington Management

. The value fund, long one of Vanguard's hallmark funds, was lagging. Weighted down with value stocks that until recently were out of favor, the fund returned only 0.8% in 1998, compared with the 28.6% return of the

S&P 500

and the 14.7% return of the

S&P Barra Value Index

.

Faced with that performance, Molitor says he first asked such basic questions as whether a fund like Windsor was justified at Vanguard. Did the firm want to stick with value, even though it was out of favor? If so, did it want to stick with Freeman as its manager? The answer to both questions was yes, Molitor concluded, but he wanted a fresh perspective.

"We ... wanted to temper the risk of the portfolio -- not change the dynamic of it, but just take a little bit off the edges, if we could," says Molitor.

As value stocks have mounted a comeback in recent weeks, Windsor is now up 18.2% for 1999, compared with the 9.6% year-to-date return of the S&P 500, according to

Morningstar

. And after the addition of the Bernstein managers, the portfolio is broader as well.

Poor performance doesn't always signal a need for a change, however. In 1993, Molitor noticed that the

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Vanguard Primecap fund was coming off a period of underperformance.

"The gentle way of saying it is that it was an undistinguished record," Molitor says.

He went to work, reviewing the holdings of manager Howard Schow of Pasadena, Calif.-based

Primecap Management

. But in that case, Molitor decided the fund just needed more time for markets to come back around in its favor. Turned out he was right.

"It became so hot we had to close it down" not once, but twice, first in 1995 and again in 1998, Molitor says. The fund has now slightly outpaced the S&P 500 over the past five years.

Molitor says Vanguard's unique structure -- its index funds are run in-house and its active funds are managed by outside advisers -- gives the firm a special kind of diversity. Because active funds are managed by different companies -- and have different analysts working on them -- you won't find the same

cookie-cutter portfolios as those at some other large fund firms.

"We cherish the idea that we have this independence of thought," Molitor says.

But lest any of its management teams becomes too independent, shareholders can rest assured: Molitor will be watching.