Is the Agg Enough for Your Fixed Income Portfolio?

Just as investors regard the S&P 500 or various equity market indexes as representative of the U.S. stock market, many believe the Bloomberg U.S. Aggregate Index (the Agg) is the proxy for the entire U.S. bond market.

But unlike the stock indexes, the Agg (and its sister index, the float-adjusted version) only offers partial exposure to a U.S. bond market. And keep in mind that the U.S. bond market makes up only 40% of the global fixed income market.

That means investors who track the Agg in their fixed income allocations miss out on a wider playing field, which would increase diversification and offer the opportunity to outperform.

A simple way to solve that problem: active ETFs.

^{Sources: Center for Research in Securities Prices, Securities Industry and Financial Markets Association, and Bloomberg, as of June 30, 2023.}

^{Source: Securities Industry and Financial Markets Association, as of December 31, 2022.} 

What's in and out of the Agg?

^{Source: Bloomberg and Securities Industry and Financial Markets Association data, as of December 31, 2021, the latest year for which complete data is available.}

Beyond the Agg

A bevy of more narrowly focused index-based ETFs can target areas such as high yield, emerging markets, or mortgage-backed securities. International bond ETFs can access the investment-grade non-U.S. sovereign, corporate, and securitized bonds.

But then investors must decide which ETFs to use and how much to invest to replicate the $130 trillion global fixed income market. If they are using ETFs focused on select areas of the market, they must consider when to rebalance, overweight, or underweight those positions.

A football analogy may explain how active ETFs can simplify this process for investors. During a game, defensive coordinators decide how many linemen, linebackers, and defensive backs to use on each play, depending on the score, the down, distance to a first down or a score, and time remaining on the clock.  

Professional fixed income managers play a similar role. For example, they must decide— depending on credit spreads, interest rates, and economic news—how to allocate the portfolio between U.S. Treasuries, investment-grade corporates, high-yield, emerging markets bonds, and other options. They select individual securities just as coaches pick specific players for a given play.

The question to ask yourself then is: Are you the best possible fixed income coordinator for your own team? Or are you the head coach of your portfolio, and it’s best to hire professionals to act as the fixed income coordinator?

Two New Vanguard Active Bond ETFs

Vanguard has recently launched two new active bond ETFs: Vanguard Core Bond (VCRB) and Vanguard Core-Plus Bond (VPLS), which both provide actively managed exposure to the U.S. fixed income market.

• VCRB has a higher-quality bias, as it focuses primarily on investment-grade corporate bonds, Treasuries, and agency mortgage-backed securities, with only selective exposure to high-yield, emerging markets, and non-U.S. corporate bonds. It has an annual alpha target of 60 basis points against its benchmark, the Bloomberg U.S. Aggregate Float Adjusted Index.
• VPLS has an annual alpha target of 75 basis points against its benchmark, the Bloomberg U.S. Universal Index (known as the “Universal”). It also provides exposure to U.S. government debt and investment-grade corporates, but it has greater flexibility than VCRB to invest in high-yield corporate and emerging markets bonds.
• For both ETFs, the majority of alpha is expected to be driven by sector allocation, as managers overweight or underweight U.S. Treasuries, mortgage-backed securities, investment-grade corporates, emerging markets, and high-yield bonds. Individual security selection will also play a large part in alpha generation.

A Universe of Additional Opportunity

Vanguard considers the Bloomberg U.S. Universal Index to be a better benchmark than the Agg for a core-plus strategy because of its more comprehensive exposure to the U.S. bond market. In addition to holding the categories in the Agg, the Universal also includes U.S. high-yield corporates, greater exposure to structured products and (dollar-denominated) emerging markets, and other less mainstream bond sectors.

These sectors have more credit risk, but often less interest rate risk. They also tend to offer high yields and greater opportunity for selection and allocation decisions for active managers.

• Both VCRB and VPLS are designed to serve as the centerpiece, or even the only piece, of an investor’s fixed income allocation. 

A tale of two benchmarks 

^{Source: Bloomberg Fixed Income Index Methodology, published September 29, 2023.} 

The Bloomberg U.S. Universal Index tracks more of the available issuance of the U.S. fixed income market 

^{Sources: Bloomberg and Aladdin, as of December 31, 2023.} 

The Value of Ownership

Vanguard is an investment company owned by the people who invest in our funds. That means our investors are our owners¹, and we can take a different approach to active fixed income:

1. Costs less: We pass along economies of scale, which helps us keep our expense ratios low and enables investors to keep more of their return.
   •    VCRB has a 0.10% expense ratio; VPLS’ expense ratio is 0.20%. 
    
2. Smart risk-taking: Because we don’t have to overcome large management fees like our competitors, we can be selective about the risks we take. 
    
3. True to label: Our funds are managed within guardrails to remain true to their investment mandates and based on solid investing principles.

Separate and Distinct

VCRB and VPLS share the benchmarks, management teams, and expense ratios of the Admiral share classes of their respective mutual fund counterparts: Vanguard Core Bond Fund and Vanguard Core-Plus Fund. However, they are separate and distinct products. Natural differences in total asset size, client cash-flow activity, and other factors will result in differences in fund holdings and, in turn, modest differences in fund performance between the corresponding ETFs and mutual funds, particularly over shorter time periods.

¹ Vanguard is owned by its funds, which are owned by Vanguard’s fund shareholder clients.

Vanguard Core Bond ETF and Vanguard Core-Plus Bond ETF are not to be confused with the similarly named Vanguard Core Bond Fund and Vanguard Core-Plus Bond Fund. These products are independent of one another. Differences in scale, certain investment processes, and underlying holdings between the ETFs and their mutual fund counterparts are expected to produce different investment returns by the products. To obtain a prospectus for Vanguard Core Bond Fund or Vanguard Core-Plus Bond Fund, please call 800-662-7447.

For more information about Vanguard funds or Vanguard ETFs, visit vanguard.com to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

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. Past performance is no guarantee of future results.

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. Past performance is no guarantee of future results.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

Investments in bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.

High-yield bonds generally have medium- and lower-range credit-quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit-quality ratings.