The bond market today is very different from recent years. Bond fund managers must carefully balance two key goals for investors: protecting capital and generating income. Sometimes these goals conflict, so managers must take smart, calculated risks.
The $13.8 billion Vanguard Core Bond fund focuses on diversification and risk management. Fund managers trim exposure when needed but also take small, strategic bets when opportunities arise. They keep cash reserves ready to invest when the market presents good chances.
Arvind Narayanan, the fund’s lead portfolio manager, maintains a focus on high-quality bonds. He believes the market outlook is not as bad as some expect. Narayanan and his co-managers, Brian Quigley and Daniel Shaykevich, also seek to diversify beyond U.S. bonds to reduce risk.
In 2024, the fund reduced its credit risk. It previously held nearly 40% in BBB-rated investment-grade corporate bonds, above the usual 30% target. This move helped the fund navigate volatile market swings. Year to date, the fund has gained 1.8%, ranking in the top 18% of intermediate core bond funds, outperforming its peers and the Bloomberg US Aggregate Bond Index.
Over the past five years, Core Bond has outperformed competitors with an annualized return of -0.6%, better than the category average of -0.7% and the index’s -1%. The fund’s low fees of 0.2% help improve returns without taking excessive risks.
Narayanan became cautious early in 2024 when investment-grade bond premiums over U.S. Treasuries did not shrink despite strong equity markets. He reduced the fund’s investment-grade corporate bonds by nearly half and minimized high-yield credit exposure. When spreads widened slightly in April, he selectively increased high-quality corporate bonds from large, stable companies.
Currently, the fund holds 28.5% in investment-grade corporate bonds, slightly underweight its normal target but still above peer averages. This reflects Vanguard’s forecast of slow economic growth between 0.5% and 1.5%, without a recession. Narayanan acknowledges recession risks but does not see it as the base case due to policy uncertainties.
The fund benefits from a global research team of nearly 50 experts. It invests in agency mortgage-backed securities (MBS), which make up 22% of holdings, and consumer asset-backed securities like prime auto loans, known for strong performance. Agency MBS, issued by government-sponsored agencies, carry high credit quality, unlike riskier nonagency MBS.
Narayanan notes many agency mortgages were made when interest rates were near zero and are unlikely to be refinanced soon. Vanguard expects the Federal Reserve to cut rates by half a percentage point later this year but does not anticipate a return to near-zero rates.
Core Bond also holds government bonds from Europe, Japan, and high-quality emerging markets. This global diversification reduces credit risk while offering higher yields than U.S. Treasuries. These purchases reflect a changed global economy compared to two years ago, when U.S. growth was strong and monetary policy was stable.
In April, the fund increased corporate bond exposure and extended its duration to about six years, slightly longer than the benchmark’s 5.8 years. Duration measures sensitivity to interest rate changes. Narayanan believes interest rates have limited room to rise further as economic growth slows.
In this volatile environment, Narayanan advises investors to avoid extreme market narratives. He emphasizes balanced, grounded decision-making over reacting to optimistic or pessimistic trends.
READ MORE:
