• Only two months into the year, markets have already endured bouts of volatility relating to proposed tariffs, the tech sector and AI.
  
  
• With volatility likely to persist in the coming months, investors will need to find ways to provide ballast in their portfolios against turbulence and potential market downturns.
  
  
• Bond ETFs offer investors a way to add a buffer to their portfolios while also providing exposure that could benefit from a potentially supportive environment for fixed income returns. 

After back-to-back years of annual US equity returns exceeding 20%, some investors have started to question the case for holding bonds¹. In our view, the merits of having fixed income in a portfolio persist, and the current market environment suggests bond investors could have cause for optimism.

Equity markets have started 2025 with some wobbles

Equity markets have had an incredible run recently. But equity prices, in particular those of US tech company stocks, are priced to perfection – in other words, valuations leave little room to absorb any surprises which could cloud the current optimistic outlook. And given recent US policy announcements and the market gyrations some of these have caused, heightened volatility could become an ongoing theme throughout 2025.

In late January, we got a taste of just how quickly negative news could trigger volatility in the stock market. When Chinese company DeepSeek announced new artificial intelligence (AI) capabilities, it caused the stocks of US rivals to tumble. And in February, the prospect of new tariffs being rolled out by the United States and its trading partners unsettled markets. Ongoing tariff negotiations mean there remain unanswered questions.

In this environment, marked by bursts of volatility and the prospect of market downturns, broadly diversified bond exposures are among investors’ most effective tools to insulate their portfolios and provide downside mitigation.

Bond exchange-traded funds (ETFs) as a portfolio shock absorber

Against this backdrop of heightened market volatility, it’s important to remember the role bonds can play in a portfolio context. Hedged global bonds, in particular, can provide a helpful illustration.

While fixed income exposures generally exhibit lower volatility than equities, hedged global bonds have consistently stood out from the pack. For example, in the past 20 years, hedged global bonds have had volatility of approximately 3% a year. This contrasts dramatically with the volatility of above 16% for equities and alternative exposures, as the table below shows.

This lower volatility is important given what it signifies with respect to drawdown protection. While equities have enjoyed higher absolute returns than bonds in recent years, the difference between the asset classes’ drawdown profiles is much more stark. For example, US and global equities have suffered declines of as much as -55% and -58%, respectively, over the past 20 years. For hedged global bonds, the maximum drawdown was -12%.

Hedged global bonds: An all-weather shock absorber

Asset classes ranked by volatility, 31 May 2004 to 31 December 2024

Past performance is not a reliable indicator for future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.  

Source: Bloomberg, Vanguard. Data is for the period 31 May 2004 to 31 December 2024 and in USD². Annualisation is based on weekly returns. The Sharpe ratio assumes a zero risk-free return.

For investors seeking ways to mitigate the risk of drawdowns on portfolios, the shock-dampening properties offered by hedged global bonds can be significant. From a risk-adjusted perspective, global hedged bonds have comfortably beaten most other asset classes—except for short-duration bond exposures—during the past 20 years³.

Beyond acting as a portfolio anchor, our research also suggests a favourable landscape for bonds going forward. As we have laid out in our 2025 economic and market outlook, we believe the higher rate environment is here to stay and thus we expect long-term bond returns to be closer to the levels seen in the early 2000s. Under these conditions, it’s likely that more of a bond investor’s returns will come from higher coupon payments that get reinvested at higher rates, rather than price appreciation.

How Vanguard adds value when managing indexed fixed income ETF strategies

A common misconception is that the managers of index exposures follow a ‘set-it-and-forget-it’ approach.

In reality, managing fixed income index funds and ETFs requires a high degree of expertise. A clear illustration of the skill required, and which plays a key part in keeping investor costs low, are the sampling techniques that some index portfolio managers use. Holding every single constituent of a fixed income benchmark is often not possible, practicable or cost-effective for the fund manager tasked with tracking the index. Through sampling, portfolio managers aim to match the characteristics and the performance of the benchmark index without incurring unnecessary transaction costs, which can erode long-term returns.

For index ETFs, the primary objective is to track the performance of a benchmark with as little tracking error as possible.

The global bond universe, which comprises tens of thousands of individual fixed income securities, is a case in point. When Vanguard’s portfolio managers aim to replicate the Bloomberg Global Aggregate Float Adjusted and Scaled Index, they hold around one third of the constituents from the 30,000+ total names in the index⁴. And, although the Vanguard Global Aggregate Bond UCITS ETF only holds one third of the individual securities, its holdings still comprise almost two-thirds of the universe by market capitalisation.

As the chart below illustrates, portfolio managers can closely match the weightings of the underlying index while holding only a portion of the index constituents. They do this by targeting specific bond issues after assessing metrics such as liquidity, credit quality, maturity and other key considerations, minimising transaction costs. Such sampling techniques also work as a liquidity management tool, which is vital during periods of market turmoil.

Index sampling: An efficient liquidity management tool

Fund and index weights by category

Source: Bloomberg, as at 30 December 2024. Data are derived from constituents for the Vanguard Global Aggregate Bond UCITS ETF and the Bloomberg Global Aggregate Float Adjusted and Scaled Index.

Even while a fund holds far fewer bonds than the index, its portfolio managers can closely match the benchmark’s essential risk characteristics such as duration, credit risk and yield as they seek to mirror the index’s performance. In the case of managing a global aggregate bond ETF, our managers have kept tracking error consistently tight across market cycles and environments – for further information, please visit our fund pages.

Want to learn more about investing with bond ETFs?

For investors who would like to explore the topic further, our ETF resources page has information on our ETF offering and fixed income exposures more specifically. For a deeper macroeconomic picture, our economic and market outlook for 2025 elaborates on how we expect the era of sound money (or the persistence of higher real interest rates) to provide a strong foundation for fixed income.

In addition, our Going global with bonds: The benefits of a more global fixed income allocation research provides a comprehensive explanation of how hedged global bond exposures can complement investor portfolios.
 

¹  The S&P 500 returned 25.7% in 2023 and 24.5% in 2024. Source: Vanguard. Data as at 31 December 2024, USD net total return. Past performance is not a reliable indicator of future results. The performance of an index is not an exact representation of any particular investment as you cannot invest directly in an index. The performance of the index reflects the reinvestment of Distribution and dividends but does not reflect the deduction of any fees or expenses which would have reduced total returns. 

² Benchmarks and indices used: US equities = S&P 500 Net Total Return Index, UK equities = FTSE All Share Net Total Return Index, developed market equities = MSCI World Net Total Return Index, global markets all cap equities = MSCI ACWI IMI Net Total Return Index, Europe equities = MSCI Europe Net Total Return Index,  eurozone equities = MSCI EMU Net Total Return Index, developed Asia Pacific ex Japan equities = MSCI Pacific ex Japan Net Total Return Index, Japan equities = MSCI Japan Net Total Return Index, emerging market equities = MSCI Emerging Net Total Return Index, global market equities = MSCI ACWI Net Total Return Index, developed market small-cap equities = MSCI World Small Cap Net Total Return Index, global aggregate fixed income = Bloomberg Global-Aggregate Total Return Index Unhedged USD, US aggregate fixed income = Bloomberg US Aggregate Total Return Index Unhedged USD, US short-duration fixed income = Bloomberg US Aggregate 1-3 Year Total Return Index Unhedged USD, US long-duration fixed income = Bloomberg US Aggregate 7-10 Year Total Return Index Unhedged USD, US government fixed income = Bloomberg US Treasury Total Return Unhedged USD, US inflation-linked fixed income = Bloomberg US Government Inflation-Linked All Maturities Total Return Index Unhedged USD, US corporates fixed income = Bloomberg US Corporate Total Return Index Unhedged USD, global short-duration fixed income hedged = Bloomberg Global Aggregate 1-3 Year Total Return Index Hedged USD, global long duration fixed income hedged = Bloomberg Global Aggregate 7-10 Year Total Return Index Hedged USD, global government fixed income hedged = Bloomberg Global Aggregate Treasuries Total Return Index Hedged USD, global inflation-linked fixed income hedged = Bloomberg Global Inflation-Linked Total Return Index Hedged USD, global corporates fixed income hedged = Bloomberg Global Aggregate Corporate Total Return Index Hedged USD, global high yield fixed income hedged = Bloomberg Global High Yield Total Return Index Hedged USD, global aggregate fixed income hedged = Bloomberg Global Aggregate Total Return Index Hedged USD, commodity alternatives = Bloomberg Commodity Index Total Return, global REITS alternatives = S&P Global REIT Net Total Return Index, global infrastructure alternatives = S&P Global Infrastructure Net Total Return Index, global private equity alternatives = S&P Listed Private Equity Net Total Return Index.

³ Sharpe ratio is a measure of risk-adjusted return. To calculate a Sharpe ratio, an asset’s excess return (its return in excess of the return generated by risk-free assets such as Treasury bills) is divided by the asset’s standard deviation.

⁴ As at 31 December 2024, the index had 30,448 securities.
 

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