Partner Insight: Active spotlight with Vanguard Global Credit Bond Fund manager

In this Q&A, we talk to Sarang Kulkarni, lead portfolio manager of the Vanguard Global Credit Bond Fund, about how to generate alpha in credit markets and the risks of unintentional beta.

The Vanguard Global Credit Bond Fund is managed by Vanguard's Fixed Income Group with Sarang Kulkarni as lead portfolio manager. Sarang is a credit specialist portfolio manager with more than 30 years' investment experience and has a focus on investment-grade and high-yield active strategies in European credit. As part of Vanguard's Fixed Income Group, Sarang employs a security selection-focused strategy that leverages the expertise of Vanguard's in-house credit research team to find undervalued securities.

1. What's your approach to managing the Vanguard Global Credit Bond Fund? Why do you believe it gives you the best chance of generating alpha in the asset class?

Fundamental credit research lies at the heart of how we identify active global credit opportunities. Using a security selection-focused strategy, we identify improving or deteriorating companies and take active views on the market's pricing of their creditworthiness. To invest in the best credit opportunities, wherever they may present themselves, our approach is based on global coverage, patience, prudence and smart risk-taking with the aim of generating consistent, risk-adjusted returns over the longer term.

As such, we seek to generate alpha from opportunities across a diversified set of issuers, sectors, security types and points on the yield curve, with the primary focus on bottom-up and relative value opportunities to construct a portfolio with a high information ratio¹. We avoid taking excessive exposure to top-down, directional risk, which tends to have a low probability of success over the long term. 

2. Tell us about the collaborative approach of the team and the scale of your resources.

Our in-house global credit research team searches globally for attractive situations based on forward-looking fundamentals. The active fixed income team comprises more than 130 global team members including more than 60 credit research analysts. They meet with bond issuers to get an understanding of their strategies, strengths and potential weaknesses. The analysts can tease out ideas that are long-term in nature as well as those that are event- or valuation-driven. Our scale and global team enable us to leverage the collective expertise of sector- and country-focused analysts, portfolio managers and traders, which gives us access to opportunities traded in markets anywhere in the world. 

3. Can you give some examples of recent interesting investment opportunities?

We have a positive view on select names within the European insurance sector, particularly those which have adopted a strategy to move away from riskier business lines to more stable opportunities. This strategy can lead to a reduction in the amount of regulatory capital an insurer needs to hold and strengthen its credit profile. 

Our disciplined investment process also allows us to identify names based on an improving credit trend in other sectors. For example, we recently had a positive view on a group which invests in consumer non-cyclical companies globally, partly driven by its business diversification into new areas. The valuation of these bonds was not initially consistent with the group's profile as a stable, consumer-focused company, although the bonds did subsequently perform strongly. 

4. How is your approach different to that of your peers?

Some active credit managers base their strategies around taking excessive bets on the direction of bond markets to generate returns, which is sometimes referred to as "levered beta" (taking more or less risk than the index the fund is managed against). This can involve strategies such as materially changing the duration profile of the fund or significantly shifting its allocation to riskier credit segments such as high-yield, hybrid or AT1² bonds. Relying on beta to generate returns in this way can be difficult to get right consistently, particularly in more volatile environments. 

Our approach is different. We believe that investors should know what they are investing in. Our fund is transparent and true-to-label, which means that as well as having the goal of achieving consistent alpha generation over the market cycle, it has a similar risk-return and asset-class profile to the assets it represents, allowing it to stay true to the character of the fund. We deliberately avoid unintended beta. If our behaviour and risk is more predictable, investors can be more confident in how to use it in their asset allocations. At the same time, we don't compromise on performance.

Rather than relying on concentrated or correlated risk positions to generate returns, our active fixed income teams aim to construct portfolios offering the best active returns relative to the risk incurred. This results in the fund having a high information ratio relative to its peer group, and better returns for the investors in the fund.

5. How would you define your active edge?

We aim to provide diversified, stable long-term relative returns and income using the full breadth, depth and experience of Vanguard's in-house Fixed Income Group. We seek to access the best opportunities while preserving the risk-dampening qualities of bonds, giving investors what they expect of the asset class - a focus on high-quality, investment-grade holdings that should act as a diversifier relative to equities through varying market conditions. Managing downside risk is key, because we believe that the ability to avoid companies or sectors facing challenging times is just as important, if not more important, than identifying the winners in active global credit markets. Rather than relying on a handful of large trades to drive the performance of the fund, we diversify our sources of alpha, which allows all our active bond funds to reduce the volatility of their returns.  

The scale of Vanguard's Fixed Income Group means we can keep investing in our people, technology and systems to deliver better returns for the funds. As a large investor with a long-term approach to investing, we have good access to company management teams. As a result, our analysts can independently assess how attractive the investment opportunity is, which can give us a head start over investors who rely solely on third-party resources, such as rating agency research or sell-side reports.  

Finally, our low expense ratio gives us an asymmetric advantage: when the opportunity set is attractive, we can take the same amount of risk as our peers. When the risk-reward outlook appears less attractive, we can reduce risk and take a more defensive approach. We can do this because of our low fees. Competitors may feel pressure to maintain higher risk to offset their higher fees.

Our active bond funds managed in-house

Vanguard Emerging Markets Bond Fund

Vanguard Global Credit Bond Fund 

 

¹ A measure of risk-return which shows portfolio returns above the returns of a benchmark relative to the volatility of those returns.

² AT1 is an acronym for Additional Tier 1 capital. It was introduced with Basel III after the Global Financial Crisis to replace the former term ‘Tier 1 Securities' term. AT1 notes are a key instrument in regulators' post-crisis bail-in regime and fulfil an important part of banks' regulatory capital requirements.

 

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