WASHINGTON — Frenzied competition among mutual fund companies for investors has led to some gimmicky marketing, a trend the Vanguard Group, known for its plain-vanilla approach to investing, has long resisted. But now, it seems, the company is succumbing.
Taxes is the latest buzzword among funds, and Vanguard is jumping in with a series of funds in July that are intended to reduce shareholders' taxes while retaining stocks.
But while "Vanguard's marketing department will have a field day selling these funds, investors already have better choices available at Vanguard," said Daniel P. Wiener, who edits the Independent Adviser for Vanguard Investors, a newsletter based Boston.
Investors will have a choice of three portfolios in the Vanguard Tax Managed Fund. The Growth and Income Portfolio will own "substantially all" of the stocks in the Standard & Poor's 500.
The Capital Appreciation Portfolio will invest in low-dividend stocks from the Russell 1000 index, which tracks the nation's 1,000 largest companies. The Balanced Portfolio will be split between intermediate-term municipal bonds and stocks similar to those owned by Capital Appreciation.
Like many Vanguard funds, these will mostly aim to approximate the performance of market indexes, though the muni bond part of the Balanced fund will use a traditional active-management approach. The low portfolio turnover that results from indexing should reduce the amount of capital gains paid to shareholders, the company says.
To reduce realized capital gains even more, each fund will select shares of securities with the highest "tax basis" when their holdings are sold. The tax basis, roughly the price paid for shares, is subtracted from sales proceeds to figure taxable gains, so selling high-basis shares creates the smallest gain.
But since index funds are low turnover by design, how much can selective selling add to the return? John C. Bogle, Vanguard's chairman and chief executive, said he was "hesitant to say" because of Securities and Exchange rules on promoting funds that are still in registration.
It's hard to see how there can be a significant difference because of the buy-and-hold approach used by index funds in general. Turnover in Vanguard's Index 500 fund last year, for instance, was 6 percent, compared with 75.5 percent for the average diversified domestic equity fund, according to Morningstar Inc., fund researchers.
But the Vanguard figure drops to a mere 2 percent when redemptions in which shareholders receive stock instead of cash are excluded.
While index-fund shares may be sold to raise cash for redemptions if other income is insufficient, the biggest sales occur when one stock is replaced in the index by another. In that case, the fund is forced to sell all of its shares and doesn't have the opportunity to choose the ones with the highest basis.
Moreover, if tax-advantaged selling -- that is, selling shares with the highest basis -- is so valuable, why doesn't Vanguard use the same approach in its other funds? They began doing so three years ago, Bogle says. So the difference tax-wise between the new funds and comparable older ones would seem to be even less marked.
Vanguard is also taking steps to offset the impact of taxes on capital gains the funds may be forced to realize because of short-term trading by investors. While shares are sold, in typical Vanguard fashion, without a sales charge, the company plans to levy a 2 percent redemption fee on shares sold within one year of purchase, 1 percent on shares sold after one year but within five years.
Besides discouraging short-term trading, the fees -- paid directly to the fund, not to its sponsor -- offset some transaction costs that would otherwise by borne by the funds' long-term investors, the company says.
Expenses for the new funds are expected to equal 0.25 percent of assets a year. That's quite low, but still much higher than annual expenses for Vanguard's Index 500, which totaled just 0.19 percent of assets in 1993.
Moreover, the portfolios have steep minimum investments of $10,000 each.
But people with less to invest can create their own tax-advantaged portfolio of Vanguard funds, without the 2 percent redemption fees, Mr. Wiener said.
For example, Vanguard's Small Cap or Extended Market index funds are good substitutes for the new Tax Managed Capital Appreciation Portfolio, he suggested. And the new Growth and Income Portfolio closely approximates the company's basic Index 500 fund.
To create a balanced fund, Mr. Wiener said, mix shares of the Index 500 with shares of the Municipal Intermediate Term fund.
Perhaps Vanguard is a victim of its own success. Its benchmark index fund is already so tax-efficient that an approach that tries -- to save more on taxes can probably have only a minimal effect.
Wiener figures the Index 500 is 91 percent tax efficient for investors in the 39.6 percent tax bracket. The fund returned 53.7 percent for the three years ended 1993, of which high-bracket taxpayers kept 48.6 percent after taxes and lower-bracket taxpayers kept even more. Taxes are low because relatively little of the gains came from either dividends or realized capital gains; most came from unrealized gains.