VANGUARD’S HEALTH CARE ACTION LOBOTOMY FOR A BAND-AID WOE?

Vanguard Group’s tough new redemption fee policy for the feverishly performing Vanguard Health Care Fund it closed last month has some advisers feeling a bit queasy.

In a move to prevent speculative investors from pumping money into the $10 billion mutual fund — and pulling out when investments sour — Vanguard announced it will impose a 1% redemption fee for shares sold within five years of purchase, vs. the previous one-year.

Much of the money pouring into the health care fund in recent months has been from new investors salivating over its 40.8% return for 1998, according to the company. In fact, fund inflows were $564 million in January — more than four times the year-earlier level.

The new redemption fee will be slapped on money entering the fund after April 18. While Vanguard closed the fund to new investors, existing shareholders can add up to $25,000 per account, and contributions will continue through automatic investment or retirement plans.

sign of future?

The new policy may be a model for tougher, longer-term fees in the future for other Vanguard funds. Vanguard already has a more restrictive policy for its Tax Managed fund series. Shareholders in those funds are slapped with a 2% redemption fee for cashing out within the first year of purchase and a 1% fee for bolting between years one and five.

“If we felt the need to stem the cash flow from speculative investors in another fund, we would not hesitate to employ redemption policies similar to this,” a company spokesman says.

Although Vanguard gets kudos from some for seeking to keep out short-term investors, others grumble that the company went too far.

They say a lot can change in any sector in five years. For instance, if lawmakers took another crack at nationalizing the health care system, many stocks could suffer.

And some disgruntled advisers say the new policy is prompting them to look at other hot health care funds, including Fidelity Select Health Care, Putnam Health Sciences and Invesco Health Sciences.

Indeed, some competitors may already be picking up investors looking for a new place to park their health care dollars. For the week of March 1, the $1.7 billion Invesco Health Sciences Fund reported taking in 30% more assets than it did during the entire month of February.

“When Hillary Clinton was working on the health care system, there was a substantial downturn in that sector,” notes Madeline I. Noveck, president of New York-based Novos Planning Associates Inc., which has $60 million under supervision.

“I am not an active trader,” adds Ms. Noveck, who has clients in the Vanguard fund. “When I feel the need to trade, it’s probably because the asset class is doing poorly.”

Michael K. Donohue, whose San Diego-based Donohue Financial/ LPL manages $35 million, says a penalty for cashing out within a year should be enough to discourage market timers.

“The economics of any specific industry can change in five years,” he says. “We will be looking for similar funds that invest in large-company names in the health care and drug industries.”

John E. Demming, a Vanguard spokesman, reports no higher level of redemptions since the new policy was announced on Feb. 25, the day the fund closed. (Any redemption fees are paid directly to the fund, which the company expects to keep closed for at least six months but no more than a year.) The fee “makes it very clear to those who are using it as a short-term trading vehicle that they aren’t welcome in the fund,” Mr. Demming says.

Of course, not all the company’s customers are miffed.

“They are encouraging the buy-and-hold investor,” says Gary H. Schatsky, president of Independent Financial Counselors in New York.

“I represent people who are investing long-term,” says Mr. Schatsky, whose firm supervises $50 million. “Retaining the fund for five years is not much of a burden.”

And even if investors chose to bail out sooner, Mr. Schatsky figures, 1% is a small price to pay for a fund that has posted such strong returns in recent years. It is “refreshing that the money is put back into the fund for the benefit of long-term investors.”

“It’s a long-term play, so to me it’s not an issue,” says Brent Kerr, a San Diego shareholder who also has money in the Invesco Health Sciences Fund. “If someone wanted to play health care, there are plenty of other funds if they don’t like Vanguard’s rules.”