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 in a time when investors are stampeding assets to low-cost, passive index funds.

"It has been a tumultuous period, but Vanguard is coming out of this ahead," said F. William McNabb III, who became the company's president and chief executive in August. "It illustrates the power of diversification. I know it must sound like motherhood and apple pie, and it sounds pretty basic, but competitors lost sight of it in the late 1990s and recently. Our success comes down to remaining disciplined."

Calling the current environment "Vanguard weather," McNabb said the firm has added customers in the past four months and is now the largest U.S. fund company, barely stealing that title from Fidelity Investments with $1.072 trillion of assets under management, compared to Fidelity's $1.069 trillion, according to Lipper.

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 McNabb personally received a ton of letters from investors.

McNabb was surprised that the letters weren't hate mail; instead investors turned to Vanguard as a trusted source for clarity about market conditions.

Tim Buckley, 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. Importantly, 80% to 90% of Vanguard's retail customers maintained their investment strategy.

"We have seen a huge amount of buying activity," 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 made 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 said McNabb's own 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, president of Bobroff Consulting in East Greenwich, R.I. "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 that have had heavy outflows and have been forced to cut staff and expenses, 2008 was Vanguard's second-best year, generating $75 billion of net inflows through November, according to 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 the first quarter, on top of the 1,300 it cut in November, Vanguard has not cut jobs.

McNabb said that Vanguard has been 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."

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," 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 website," he said. "It happens by having good people who are in place for a long time. Institutional loyalty creates client loyalty."

Bobroff isn't so sure 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.

McNabb countered that there are ways to reduce expenses without cutting jobs. Vanguard has "decent natural turnover" and can adjust its hiring to market conditions, he said. Buckley added that Vanguard takes a hard look at the projects and products 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."

McNabb added that he does not want Vanguard to spend 2009 focused only on cutting expenses but, rather, finding ways to take advantage of market conditions to foster growth. This means spending on things like technology, product development and pouncing on opportunities caused by consolidation in the fund industry. This does not mean, however, Vanguard will look to acquire, because that has never been part of the strategy for the 33-year-old company, but McNabb 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 they are going through cuts," he said. "Honestly, it is hard to figure out how they got so big."

"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."

(c) 2009 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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