Seeking alpha: Investors embracing 1-year-old active bond fund

March 28, 2017

 

Since it was launched in March 2016, Vanguard Core Bond Fund has gained a foothold with investors looking for a broadly diversified actively managed bond fund. As of February 28, 2017, the fund had amassed an impressive $658 million in assets under management. Just prior to the fund's one-year anniversary, we spoke with the global head of Vanguard Fixed Income Group, Greg Davis, and the fund's portfolio managers, Greg Nassour, Gemma Wright-Casparius, and Brian Quigley, to learn more about the fund and why it has resonated so well with investors.

Advisors are familiar with Vanguard's lineup of bond funds. How is the Core Bond Fund different?

Greg Davis: Core Bond fills a unique space within our bond offerings as our most broadly diversified active fund. We're aiming to outperform by identifying relative value opportunities that position the fund differently from its benchmark. Core Bond has many of the characteristics that you'd expect from Vanguard funds, including a broadly diversified strategy that focuses on high-quality securities and strong risk controls. The fund's overall strategy has generated a lot of interest from investors seeking to optimize their return potential without compromising the defensive role that bonds play in a portfolio, i.e., counteracting stock market risk.

Like its sibling index fund, Vanguard Total Bond Market Index Fund, this active bond fund invests across the investment-grade market, including U.S. Treasury, mortgage-backed, corporate, and asset-backed securities of varying yields and maturities.

What advantage does Core Bond have over comparable funds on the market?

Gemma Wright-Casparius: The key advantage is that you get a high-quality bond fund run by one of the largest and most reputable bond managers at a low cost. The Core Bond Fund's broad asset class exposure allows us to leverage the deep expertise of our global investment team. Guided by our market outlook, our specialized sector teams work collaboratively to identify attractive opportunities across the investment-grade landscape.

In addition to a deeply experienced and well-coordinated team, we believe low expenses are an integral part of what will potentially sustain long-term outperformance. Core Bond offers two low-cost share classes—Admiral™ Shares, which charge 0.15%, and Investor Shares, which charge 0.25%—well below the core bond fund category average expense ratio of 0.81%.* Because Vanguard charges about one-third of what comparable strategies do for the fund's Investor Shares, investors can potentially save the difference.

Low costs can give investors in Vanguard Core Bond Fund a competitive edge

The expense ratios for Vanguard Core Bond Fund are 0.25% for Investor Shares and 0.15% for Admiral Shares, compared with 0.81% for the average mutual fund peer. The average expense ratio for Vanguard's active taxable fixed income funds is 0.16%, compared with 0.93% for the average peer fund.

Sources: Vanguard and Lipper, a Thomson Reuters Company, as of February 28, 2017.

As investment managers, what are your performance goals for the Core Bond Fund? Does the fund's low cost factor in when assessing performance?

Greg Nassour: Our low cost can give our funds a significant competitive edge.

Vanguard's active taxable bond funds consistently produced higher returns than industry averages

For the one-year period ended December 31, 2016, 73% of our active taxable bond funds (19 of 26) outperformed their peer-group averages. For the three-year period ended December 31, 2016, 91% of our active taxable bond funds (20 of 22) outperformed their peer-group averages. For the five-year period ended December 31, 2016, 95% of our active taxable bond funds (21 of 22) outperformed their peer-group averages. For the ten-year period ended December 31, 2016, 91% of our active taxable bond funds (20 of 22) outperformed their peer-group averages.  Results will vary for other time periods. Only funds with a minimum one-, three-, five-, or ten-year history, respectively, were included in the comparison. (Source: Lipper, a Thomson Reuters Company.) Note that the competitive performance data shown represent past performance, which is not a guarantee of future results, and that all investments are subject to risks. For the most recent performance, visit our website at vanguard.com/performance.

Gemma Wright-Casparius: The lower expense ratios also enable us to manage the fund more conservatively. On average, we don't need to take as much risk to achieve competitive returns compared with other actively managed total-return bond funds.

For example, some bond funds use active investment approaches that may introduce significant exposure to high-yield bonds, reducing the diversification benefits many investors want. Our approach limits exposure to these high-yield bonds to 5% of holdings, which helps maintain the integrity of the Core Bond Fund's role in your clients' portfolios.

We also limit interest rate risk by imposing tight duration** constraints—generally, 0.5 year above or below the fund's benchmark, the Bloomberg Barclays U.S. Aggregate Float Adjusted Index.

Given the fund's broad mandate, can you describe the team and processes supporting the fund's management?

Brian Quigley: The portfolio managers, traders, credit analysts, and other investment professionals work closely with Vanguard's economic team, along with the global heads of interest rates, credit, tax-exempt bonds, and risk management, to gain insight into investment opportunities. Our overall strategic outlook and investment policies are determined by this team. Based on those outlooks, the team determines how aggressively or conservatively each fund should be relative to its benchmark.

This team-based approach helps us make the best decisions in our portfolio for our investors and leverages the resources and capabilities of our entire organization, including experts in the United States, the United Kingdom, Hong Kong, and Australia. This global presence lets us share local insights from a bottom-up perspective.

Greg Nassour: We're humbled by the assets entrusted to us by investors. Growth in the Core Bond Fund and other Vanguard fixed income funds has pushed assets under management past $1 trillion for Vanguard Fixed Income Group, as of June 30, 2016. More than half of that amount is invested in active strategies that seek to outperform a stated benchmark. With regard to fund performance, our active taxable bond funds outperformed their peer-group average returns by 73%, 91%, 95%, and 91% over the past one, three, five, and ten years, respectively, as of year-end 2016. For investors seeking a high-quality, diversified bond fund that aims to optimize return potential, the Core Bond Fund can serve a fundamental role in a portfolio. It offers the expertise of a world-class investment team with a strong emphasis on risk management at a low cost.

(More information about the Vanguard Core Bond Fund here.)

* Vanguard and Lipper, a Thomson Reuters Company, as of February 28, 2017.

**Duration is a measure of the sensitivity of bond—and bond mutual fund—prices to interest rate movements.

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
  • Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer's ability to make such payments will cause the price of that bond to decline.
 

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