Morningstar Magazine - October/November 2016 - 78

Investors Portfolio Anchor This new Vanguard bond fund is designed to be the centerpiece of portfolios. Low fees are a bonus. U N D I S C OV E R E D M A N AG E R Tom Lauricella In every issue, Undiscovered Manager profiles a manager on the Morningstar Manager Prospects list, which is compiled by Morningstar's manager research group. Investors weighing a Vanguard bond fund to anchor their portfolios may instinctually head in the direction of its big, broad-based index funds. But Vanguard's newest core bond offering is actively run, and its team of veteran, inhouse portfolio managers make clear they are out to beat the index. In late March, Vanguard opened the doors on its Vanguard Core Bond Fund VCORX, a strategy that aims to top the Barclays U.S. Aggregate Index. It's a high-quality bond fund that can range between U.S. Treasurys and mortgage-backed U.S. and foreign corporate debt. Vanguard Core Bond has a two-pronged strategy for beating the index: structural and strategic. The hub-composed of its senior fixed-income investment strategy group-makes the big picture macro and market segment calls. Those are then translated into more granular asset allocations at the rate and credit team levels. Then the "satellite" specialist teams do the bottom-up research and make the buy-and-sell decisions on individual securities. "The portfolio is very dynamically managed," says Gregory Nassour, who co-heads Vanguard's investment-grade credit group and is one of the managers on the Core Bond fund. "Changes do happen and they happen often." Getting Noticed Morningstar added the Core Bond fund to the Prospects list of up-and-coming or under-theradar strategies in the second quarter. Since Morningstar launched the Prospects list in the third quarter of 2014, there has only been a handful of funds with short track records added onto the watchlist for possible full coverage by Morningstar's manager research team. But the Core Bond fund joins Vanguard TaxExempt Bond Index Fund VTEBX as among those added within months of their launch. Structurally, the fund gains a significant tailwind in the form of its extremely low 0.25% expense ratio on the investor class shares. That expense ratio clocks in at less than one-third the average fee charged by intermediate-term bond funds. "It's a nice option for those looking for diversification potential," says Sarah Bush, the director of fixed-income strategies with Morningstar's manager research group. "It's a fairly straightforward, plain-vanilla fund." On the strategic side of the fence, the portfolio aimed at beating the benchmark is built through what Vanguard calls its "hub and satellite" approach. Bush notes that with Vanguard's low-fee advantage, the fund can stay away from highyield bonds or emerging-market bonds that competitors need to boost returns but also can end up increasing a portfolio's correlation to stocks. The high-quality bias, she says, could tend to lead to some underperformance compared with other funds during periods when junk bonds are doing well, as has been the case for bonds recently. But, Bush says, "the core advantage is very, very low fees." The fund returned 3.5% since its March 28 launch through August, compared to 3.3% for the Barclays Aggregate Index and 3.8% for Intermediate-Term Bond Morningstar Category. Seasoned Crew While Core Bond is brand new, the team behind it is far from green. Nassour is a 24-year-veteran at Vanguard, whose responsibilities include the $57 billion Vanguard Short-Term Investment-Grade Fund VFSTX, which carries a Morningstar analyst rating of Silver. The Short-Term fund ranks in the top quintile of its category for its one-, three-, and five-year returns. Also on the team is Gemma Wright-Casparius, who runs Vanguard's Treasury and inflationprotected group and has 30 years of investment experience, including five years at Vanguard. Among her charges is managing the Gold-rated, $25 billion Vanguard Inflation-Protected Securities Fund VIPSX, which landed in the top quintile of its Morningstar Category over the trailing five-year period. A third co-manager is Brian Quigley, head of the agency mortgage and volatility team. Quigley has 11 years of investment experience under his belt and runs the Silver-rated, $6 billion Vanguard Short-Term Federal Fund VSGBX. That fund's returns have landed it in the top quartile of the short government category over the trailing five-year period. Attracting Attention 78 Morningstar October/November 2016 Investors have been quick to jump into the Core Bond fund despite its lack of a track record. By the end of August, assets were more than $600 million.

Table of Contents for the Digital Edition of Morningstar Magazine - October/November 2016