As we take a look at what’s behind the headlines, fixed income exchange traded fund investors should consider a new take on bonds.
In the recent webcast, A Vanguard Deep Dive: What’s Next for Fixed Income, Janel Jackson, Vanguard’s principal and head of U.S. ETF capital markets, outlined what is happening in the current market today, with record equity ETF cash flows in 2021 as investors continue to rotate and funnel money into value. International ETFs also continued to carry through with their early 2021 momentum.
Meanwhile, fixed income ETF cash flows were well-diversified and positive for 80% of products. Looking at inflows, the intermediate core/core plus and inflation categories remained popular areas of interest among bond investors, while the ultra-short duration and long government categories saw slight outflows.
Given the current pacing of ETF cash flows, Jackson predicted that total year-to-date ETF cash flows could cross $900 billion this year. The ETF cash flows also indicate that more investors and financial advisors are increasingly allocating to passive fixed income strategies.
Looking ahead, Arvind Narayanan, Vanguard’s co-head of investment grade credit and senior portfolio manager, argued for maintaining core fixed income portfolio exposures to continue riding out the current fixed income environment.
“We disagree with the who suggest abandoning fixed income, especially in exchange for more exotic—and usually more expensive—alternatives. The path forward may be difficult, but we believe an allocation to fixed income will still diversify against equity risk in client portfolios,” Narayanan said.
“We’ll be watching for higher, and more persistent realized inflation—a key risk factor. After a short-term spike this spring, we expect inflation to remain contained over the long term, anchored by population demographics, income inequality, globalization and technology,” Narayanan added. “Market pricing has pulled forward expectations for future rate hikes, running well ahead of the Federal Reserve’s forward guidance. We expect the Fed to remain committed to an accommodative policy for some time.”
Touching upon inflation, one of the highest perceived risks ahead, Narayanan highlighted Vanguard’s Treasury Inflation Protected Securities strategies to help investors limit inflation on their wealth. Specifically, ETF investors can look to something like the Vanguard Short-Term Inflation-Protected Securities Index Fund ETF Shares (VTIP). VTIP seeks to track the Bloomberg U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Year Index performance. The index is a market capitalization-weighted index that includes all inflation-protected public obligations issued by the U.S. Treasury with remaining maturities of less than five years.
Narayanan also argued that investors can consider an active approach with a well-disciplined management team who are more in-tune with market conditions to make adjustments on the go and respond to risks that may pop up. Vanguard’s active fixed income investment process includes a senior investment committee and an investment strategy group to inform top-down views on the economy, policy, and longer-term return outlook. Sector teams assess bottom-up fundamental, technical, and valuation opportunities. In addition, a credit and rates strategy team leverages top-down and bottom-up inputs to form a baseline strategy.
For example, the Vanguard Ultra-Short Bond ETF (VUSB), which was launched in April and has already amassed $1.7 billion in assets under management, offers the features of an ETF structure for investors seeking an option for anticipated cash needs in the range of six to 18 months, according to Vanguard. The fund is designed to give investors low-cost exposure to money market instruments and short-term high-quality bonds, including asset-backed, government, and investment-grade corporate securities. The ultra-short strategy bridges the gap between money market funds offering a stable share price and short-term bond funds, which are meant for longer investment time horizons.
VUSB is a similar strategy to that of the much larger actively managed Vanguard Ultra-Short-Term Bond Fund (VUSFX), which debuted in 2015. Both the fund and the new ETF invest in diversified portfolios consisting of high-quality and, to a lesser extent, medium-quality fixed income securities, including investment-grade credit and government bonds. However, the ETF also provides investors and advisors the flexibility to trade at intraday market prices. VUSB also comes with a cheap 0.1% expense ratio.
Financial advisors who are interested in learning more about the fixed income market can watch the webcast here on demand.