Vanguard Global Credit Bond Fund

GC_Q4 2025 update

ANDREW SURREY: Welcome to the Q4 2024 update for the Vanguard Global Credit Bond Fund. By avoiding large macro bets, reducing downside risks, and the steady accumulation of small positive alpha over time, this active fund, run by Vanguard's Fixed Income Group, remains the number one performer in its Morningstar category.

It's had over 10% cumulative alpha after fees since inception in 2017. But more importantly, it's outperformed both its peer group and its benchmark in every calendar year since inception and continues inevitably to attract strong investor interest. Joining me to discuss the quarter and the outlook for 2025 is Lead Portfolio Manager Sarang Kulkarni.

So, Sarang, in Q4, inflation remains sticky. The Fed was a little bit less dovish, despite cutting rates. Spreads were kind of flat. How did you see Q4 playing out for your asset class?

SARANG KULKARNI: Q4 was interesting because you did see a turnaround in inflation. Literally, every month in Q4, you saw inflation year over year figures tick up a little bit. And that just made the market think about really, are central banks going to be as dovish as they thought it would be?

And you saw bond yields sell off on the back of that. But that really didn't have much impact on the credit markets. I mean, if anything, just given the strong fundamentals that credit markets are in and with what's happening on the corporate sector, you actually saw a lot of money coming into the asset class, because every time yields went up, it started hitting certain targets for maybe institutional investors, where it's at the long end for pension funds that are being entrusted.

And so they're pretty strong flows coming into credit markets, especially in December, as you saw a reallocation away from other asset classes. And that's why December was a pretty strong month for credit performance.

ANDREW SURREY: In the quarter, your fund generated a strong but very typical 17 basis points of alpha for that quarter sales, 88 basis points for the year as a whole and on an unsung basis. What drove that performance?

SARANG KULKARNI: Well, as always, we like to diversify our sources of performance. And there were a number of traits that we had on that actually did contribute to it. So one was we tried to assess what could be the potential impact of the US elections.

And we looked at it for currency markets. We looked at it for rates markets. We looked at it in the FX market. And we didn't see that asymmetry in spreads or in rates. But we did see that asymmetry in FX.

So the fund was at a small short position in euros. And that actually sold off quite a bit after the Trump victory. So that helps on the performance. We did have small underweights set up for rates. So that also helped us as well.

But by and large, the selection was a key driver. And it was a really good quarter for Europe. There was so much going on. You've got the UK water sector, which is very volatile. And you finally saw resolution coming through over there. I think we were positioned nicely for it. The REIT sector continued to perform. So there were lots of opportunities that helped drive that performance.

ANDREW SURREY: So yields are higher, but spreads are tight. You get into the point where the risk-reward profile for being in credit is less favorable?

SARANG KULKARNI: Yeah. It's an interesting question, because as I said, spreads are tight. But as history has shown us, spreads can stay tight for extended periods of time. And it really depends on how stable the outlook is, both for corporate fundamentals as well as for government, for the rates markets.

Now, for us primarily, trying to time markets and trying to decide where spreads are going to go and use that to drive performance is not the core theme that we go on. And this is where the advantage having a global fund over a regionally focused fund is quite different, because if you can't find opportunities in the US, you might find it in Europe. Or you might find it in the UK, or you might have to look at in emerging markets. Or if it's not an IG, then it could be in high yield.

So we're always finding places where we can-- where there is-- a simple example, if you look at, say, the front end of the US dollar curve, in spread terms, it's extremely tight. But for the same names, if you switch your holdings from US dollars to Australian dollars, you can sometimes pick up three times the spread. So there are ways in which you can continue to add alpha without actually adding to your outright credit risk or increasing your credit beta or trying to time markets from that perspective.

ANDREW SURREY: That's where having a global team with your pass-the-book process really helps give you those options in that playbook.

SARANG KULKARNI: Yeah. We want to find the best ideas, wherever they are.

ANDREW SURREY: And diving into some of the sector-specific opportunities, you continue-- you mentioned UK water. How do you as a team make sure you've been paid for that operation and regulatory risk that definitely exists in that sector?

SARANG KULKARNI: Look, there is no shortcut to fundamental research. You can't rely on rating agencies. You can't rely on banks. You have to crunch the numbers yourself. And we took a very interesting approach.

When we did our fundamental modeling and stress testing, we try to look at it from the perspective of every single stakeholder. Like, what does the regulator get out of this? What does the consumer get out of this? What do bondholders get out of this? And what do equity holders get out of it?

And any which way we tried, we just could not get the numbers to add up for Thames. And there's a lot of uncertainty around names like Sutton. But we were comfortable with other names. And so within the water sector, that's how we position. We saw spreads were interesting. They were attractive. They didn't reflect the risk that it was in. But of course, some risks were justified because Thames continue to deteriorate over the quarter.

Southern continued to get downgraded over the quarter. But other names actually have done really well. And so our fundamental research was really important in making sure that we could have the conviction to stay invested in names that we liked when the market was volatile and not tell the market what we need-- what we should be doing but actually just have our own convictions around how things might play out.

ANDREW SURREY: And another sector where you continue to have happy hunting is European REITs. Can you give us an example of security selection there and how you found an edge?

SARANG KULKARNI: Well, again, it's all-- it's fundamental research driven. And this is where your research and sometimes the engagement that we have with companies, it gives you the ability to hold on to your positions even though they're volatile. Some of the names that we've had, obviously, were very unpopular for a time.

And if you look at actually 2023, some of these names were the biggest detractors in the fund. But in 2024, they are the biggest contributors and by more than how much they detracted in 2023. And we could have gone when the market's really volatile. Let's just cut our losses. Let's sit and wait.

But we managed our position responsibly. We've got a very strong concentration approach in terms of how we use quantitative analysis versus quantitative analysis to assess how to size positions in the fund. And we stuck with that. We added risk as we got more comfortable with it.

And so that was one-- those-- that was the general theme. But at the end of the day, it was basically fundamental research, being able to run stress tests, being able to see, what options do management have? That was the case in one of the names in the German real estate space, where the underlying business was pretty strong.

Some of the challenges that the company was facing was created by management. And I think management themselves did a really good job of finding a way out of it. But for us to have that conviction, it would not have been possible if we didn't have continued engagement with the management team with that.

And for some of the other examples it was just really looking at documentation, understanding the difference between corporate structures, understanding the difference between accounting policies, between how some REITs in Europe account for their assets versus some of the REITs in the US. And just knowledge of this fundamental research, everything that's given, driven bottom up, actually helps us hold on to these positions and add on to them the market's quota.

ANDREW SURREY: And changing tack a little bit, you talked about flows being strong from the institutional space, because their return profile's attractive to them. How about the other side of the coin with issuance? In Q4, was that what are you expected? And what's your view on issuance going forward?

SARANG KULKARNI: I don't really have a strong view on issuance. I mean, I know people pay a lot of attention to it, but it's just business as usual. Bonds get issued. Bond matures. Companies need to issue new bonds. I mean, I think there's this huge amount of focus on the impact of issuance on markets. But I don't think it's been that impactful at all.

ANDREW SURREY: So your alpha's not relying on finding it?

SARANG KULKARNI: No, not at all. What is-- I think over '24, was really interesting, was the amount of demand that came into fixed income as an asset class. And we still see the trends and the reasons why that should continue in 2025. If you look at especially like the European markets and the IG markets, I think the demand was probably more than the net issuance that happened.

So that was quite unique because normally, you see a lot more bonds coming to the market than money coming into the asset class. But this time the technicals were really favorable.

ANDREW SURREY: And one question we've had from clients was around the news around DeepSeek on the equity side and the impact that's had on some specific equity securities. Has any of that filtered through into your world?

SARANG KULKARNI: I wish.

[LAUGHTER]

Our investment style basically benefits from when volatility goes up, when it's very selection driven, where it's very bottom up. The more dispersion you have between names, the more it translates into alpha for us. So it hasn't really factored through. But I have a much more philosophical view on this stuff. I mean, it's bound to happen.

I was reading somewhere that in the 1860s, railways made up 50% of stock indices. Today, where are they? There's nowhere. If you go back a little further back, you might have seen industrial companies and conglomerates making up a big chunk. And they're nowhere.

So from a philosophical perspective, you should expect leadership and equity indices to change. And technology is notorious because the technology companies have to reinvent themselves, because their rate of obsolescence is a lot more than other sectors might have. So do I know when this is going to happen? Is it a 2025 story? Is it a 2026 story? I don't know. But if you're paying 40, 50 times for a company, I think these factors might start weighing on them at some point in time.

ANDREW SURREY: And with that in mind, what role do you see your fund playing in a typical client portfolio?

SARANG KULKARNI: I mean, this is-- we've been flagging this for a while. This is the golden era of fixed income, because if you look at different scenarios for growth and for inflation and how economies might play out, the interplay between spreads and yields is actually quite interesting, to the point in most scenarios, you should be expecting a positive return, apart from the one scenario where, I'd say, if inflation really picks up again and the Fed has to hike-- so not just stay where they are, but they actually have to hike, that's where you could see negative returns from credit. But I think that may be low single digits.

I don't know how the equity market would react to that and whether you'd have bigger losses or-- but from-- that's the worst case scenario. On a weighted average basis, you're looking at something like 5 and 1/2% to 6% return over 2025, from credit as an asset class. And then, of course, with active management on top of that, you can add more value.

ANDREW SURREY: I agree with everything that you've said. Most scenarios look for a very rosy picture for 2025, a core part of a client's portfolio. Sarang, as always, thank you very much.

SARANG KULKARNI: My pleasure.

GC_Q4 2025 update_Cutdown

Welcome to the Q4 2024 update for the Vanguard Global Credit bond fund. By avoiding large macro bets, reducing downside risks, and the steady accumulation of small positive alpha over time, this active fund, run by Vanguard's fixed income group, remains the number one performer in its Morningstar category. It's had over 10% cumulative alpha after fees since inception in 2017. But more importantly, it's outperformed both its peer group and its benchmark in every calendar year since inception and continues inevitably to attract strong investor interest.

Joining me to discuss the quarter and the outlook for 2025 is lead portfolio manager Sarang Kulkarni. So Sarang, in Q4, inflation remains sticky. The Fed was a little bit less dovish, despite cutting rates. And spreads were kind of flat. How did you see Q4 playing out for your asset class?

Yeah, Q4 was interesting staying because you did see a turnaround in inflation. Like, literally every month in Q4, you saw inflation year-over-year figures tick up a little bit. And that just made the market think about really, are central banks going to be as dovish as they thought it would be?

And you saw like bond yields sell off on the back of that. But that really didn't have much impact on the credit markets. If anything, just given the strong fundamentals that credit markets are in and with what's happening on the corporate sector, you actually saw a lot of money coming into the asset class. Because like every time yields went up, it started hitting certain targets for maybe institutional investors where it's at the long end for pension funds that are being entrusted.

And so they're pretty strong flows coming into credit markets, especially in December, as you saw like a reallocation away from other asset classes. And that's why December's a pretty strong month for credit performance.

And in the quarter, your fund generated a strong, but very typical 17 basis points of alpha for that quarter, as 88 basis points for the year as a whole and on an unsung basis. What drove that performance?

Well, as always, we like to diversify our sources of performance. And there were a number of traits that we had on that actually did contribute to it. So one was we kind of tried to assess what could be the potential impact of the US elections.

And we looked at it for currency markets. We looked at it for rates markets. We looked at it in the FX market. And we didn't see that asymmetry in spreads or in rates. But we did see that asymmetry in FX.

So the fund was at a small short position in euros. And that actually-- the sold off quite a bit after the Trump election victory. So that helped some of the performance.

We did have small underweight set up for rates. So that also helped us as well. But by and large, the selection was a key driver and it was a really good quarter for Europe. There was so much going on. You've got the UK water sector, which is very volatile.

And you finally saw resolution coming through over there. I think we were positioned nicely for it. The REIT sector continued to perform. So there were like lots of opportunities that helped drive that performance.

And with that in mind, what role do you see your fund playing in a typical client portfolio?

This is, and we've been flagging this for a while-- this is the golden era of fixed income. Because if you look at different scenarios for growth and for inflation and how economies might play out, the interplay between spreads and yields is actually quite interesting. To the point that in most scenarios, you should be expecting a positive return. Apart from the one scenario where I'd say, if inflation really picks up again and the Fed has to hike.

Yep.

So not just stay where they are, but if they actually have to hike, that's where you could see negative returns from credit. But I think that may be low single digits. I don't know how the equity market would react to that and whether you'd have bigger losses or [INAUDIBLE] that's the worst case scenario. On a weighted average basis, you're sort of looking at something like 5.5% to 6% return over 2025 from credit as an asset class. And then, of course, with active management on top of that, you can add more value.

I agree with everything that you've said. Most scenarios look for a very rosy picture for 2025, core part of a client's portfolio. Sarang, as always, thank you very much.

My pleasure.