Portfolio perspectives

Know what’s in your bond funds to avoid hidden risks

In times of market uncertainty and volatility, it's crucial to revisit the role of core and core-plus bond funds. These funds are designed to act as a stabilizer, providing cushion during market downturns. However, some bond funds take on additional risks, which can reduce their effectiveness.

The intermediate core and core-plus bond categories are traditionally the centerpiece of a “core” fixed income portfolio, emphasizing investment-grade bonds and Treasuries with small allocations to high-yield fixed income. Our analysis shows that many active core and core-plus bond managers have historically overweighted credit and high-yield exposure relative to their benchmarks (Figure 1). This highlights the need for due diligence to identify hidden risks in bond allocations.

Source: Vanguard Investment Advisory Research Center analysis using data from Morningstar, Inc.

Notes: Risk factor exposure was calculated using monthly return data for active intermediate core and core-plus fund managers from 2015 thru 2024. Credit, term, and high yield were regressed on each active fund and the U.S. Aggregate bond index over the entire time period.  We calculated the beta exposures for active bond funds among Core and Core-Plus categories as well as the Morningstar style benchmarks using the ordinary least square (OLS) regression over the last 10 years. The following model was leveraged: (Fund return minus the USTREAS T-Bill Auction Ave 3 Mon) = α + β₁ Term+ β₂ Credit + β₃ High Yield + μ. Where the term factor is the Bloomberg U.S. Treasury Long minus the USTREAS T-Bill Auction Ave 3 Mon, the credit factor is the Bloomberg Barclays U.S. Credit (duration adjusted), and High-yield factor is the Bloomberg High Yield Corporate minus Bloomberg U.S. Long Credit.

Some types of bond funds can act more like equity funds

Your clients may appreciate the role of bonds the most when stock prices are falling. Understanding how bond funds perform relative to equities is key to ensuring that your clients are getting their intended risk exposures. If the returns of your core and core-plus bond allocation are highly correlated with those of equities, then it would illustrate the need to take a deeper look into the portfolio (see Figure 2). The bond manager may be taking on riskier exposures or allocations that are more typical of the riskier bond categories and potentially reducing the diversification benefit in times of equity market turmoil.

Get shock absorption when your clients need it

Core and core-plus bond holdings often aren’t the most exciting holdings in a portfolio. When the economy is strong, other types of bond funds may perform better simply by taking on more risk. That risk may include areas of the bond market with lower credit quality but higher yields. These categories can serve a role for those with higher income needs, while not providing as much equity diversification. Figure 3 shows that riskier bond categories tend to underperform during equity market stress.
 

Low costs can help

Low costs and strong performance are hallmarks of Vanguard’s fixed income funds. Among Vanguard’s lineup of active fixed income funds, 100% are now in the lowest cost decile of their Morningstar category.¹ Our average expense ratio for index fixed income ETFs is only 0.037%.² And our active fixed income ETFs have an average expense ratio of 0.105%—the lowest among leading issuers of such ETFs.³ We believe our funds’ low costs are a significant contributor to our impressive long-term performance. For the 10 years ended March 31, 2025, 91% of Vanguard active fixed income funds outperformed their Lipper peer group averages.⁴ This means our managers can put to use the full breadth of our expertise and sophistication to take active risk to outperform, but also have room to reduce risk when the market is not rewarding risk-taking.

Identifying risk areas in clients’ strategic bond allocations and portfolios 

It’s important to consider the level of risk being taken by a bond fund, the costs being paid, and the risk-return tradeoffs. Further, this risk is increased when multiple credit-sensitive strategies are combined in a portfolio—making it harder to understand and manage the hidden risks.   Our investment team has specialized tools and analytics to help advisors evaluate the current risks in their portfolio and think through solutions to manage portfolio risk. As a next step, let's set up a consultation for you with our investment specialists to help you zoom into the risks specific to your portfolio or leverage our Portfolio Analytics Tool. 

And if you want a true-to-label core or core-plus fund with clear limits on higher risk allocations, you may want to consider Vanguard Core Bond ETF (VCRB) or Vanguard Core-Plus ETF (VPLS).