Thanks to the rise of low-cost ETFs, active management is finally having its day in the sun. Investors have started to realize the benefits of an active approach when it comes to investing and exchange-traded funds make that all possible. Low fees, better tax savings and enhanced returns are all hallmarks of investment vehicles.
But it’s not just investors who have started to realize active management’s potential.
Indexing and passive investment titan, Vanguard, has quickly adopted the active ETF approach and, more recently, launched two new active fixed income ETFs. With the addition of these funds to its lineup, the indexing pioneer is giving active management a big stamp of approval.
Indexing Pioneer
Jack Bogle didn’t actually invent the idea of index investing. Edward Renshaw and Paul Feldstein at the University of California technically wrote the first paper on it, while John Andrew McQuown at Wells Fargo designed the first fund to track the S&P 500 for pension plans. Bogle, however, did popularize indexing with regular retail investors.
Launching Vanguard in the 1970s and the first index fund for retail investors, the asset manager hasn’t looked back. Today, Vanguard has over $7.2 trillion in assets under management – much of which is locked away inside index fund strategies. This includes ETFs, which the firm, again, was an earlier adopter of.
Needless to say, indexing and passive investment runs deep in its DNA.
Active Launches
So, when the passive pioneer decides to launch active funds, it’s a big deal. At the end of December, it did just that, by adding two active funds to its lineup of nearly 80 actively managed investment vehicles.
The two funds are the Vanguard Core Bond ETF and the Vanguard Core-Plus Bond ETF. The Core Bond ETF will provide exposure to U.S. investment-grade bonds but allow small and tactical exposure to higher risk sectors, such as junk bonds and emerging market debt. The Core-Plus Bond ETF will be similar but allow for great allocations and flexibility in terms of high yield and riskier holdings. Both funds will be actively managed to potentially beat their respective indexes.
There’s a good chance that Vanguard will deliver on that front. According to the firm’s own data, over the last decade, 94% of its actively managed funds beat their peer-group averages. 1
The kicker is that these new ETFs are not share classes of two already-in-place mutual funds: the $8.6 billion Vanguard Core Bond Fund Investor Shares (VCORX) and the $450 million Vanguard Core-Plus Bond Fund Investor Shares (VCPIX). Vanguard’s long held patent for allowing its ETFs to be considered share classes of its mutual funds expired recently – and that patent only covered index and passive strategies. The SEC hasn’t allowed its use for active ETFs. Although, several firms including Fidelity and DFA have filed for relief to use it for active ETF products. With the recent spot bitcoin ETF drama finally over, the SEC may now have time to address those proposals.
The new Vanguard ETFs follow the same mandates, benchmarks, management teams and expense ratios of the admiral class versions of the mutual funds. They are essentially mirror images of each other. However, as we’ve seen with other copycat active ETFs, the ETF usually wins out over the mutual fund. Smaller assets under management, lower expenses, as well as less tax and cash drag due the creation/redemption mechanism drive outperformance.
Bonds are Great With Active
The interesting thing about Vanguard’s launch is that it follows a trend for the firm. Its last active ETF was launched two years ago. That fund, the Vanguard Ultra-Short Bond ETF, was also a fixed income fund.
Bonds have quickly become the place for active managers to shine. There’s over 65,000 fixed income securities U.S. alone, and often major indexes come up short in their allocations and exposures. Many times, fixed income indexes will overweight those entities with the most debt outstanding, providing exposure to the biggest debtors. Meanwhile, many leave out whole swaths of the market.
But active managers don’t have to look like the index. They can overweight segments, change durations and buy values amid the wreckage. As such, many active bond funds are able to outperform their benchmarks consistently.
ETFs have unlocked those benefits. As we said in the opening, lower fees and lower tax potential have driven the extra return potential of active management into the stratosphere. By using the structure, investors can actually reap the benefits. With that, many firms – not just Vanguard – have launched active bond ETFs over the last year.
Vanguard Active ETFs
These ETFs are selected based on Vanguard’s active management expertise. They are sorted by their YTD total return, which ranges between -2.5% and 1%. Their expense ratio ranges from 0.10% to 0.18%, while they have AUM between $63M and $4.1B. They are currently yielding between 0% and 5.2%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| VFMO | Vanguard U.S. Momentum Factor ETF | $319M | 1% | 1.1% | 0.13% | ETF | Yes |
| VFMV | Vanguard U.S. Minimum Volatility ETF | $89M | 1% | 2.4% | 0.13% | ETF | Yes |
| VUSB | Vanguard Ultra-Short Bond ETF | $4.09B | 0.2% | 5.2% | 0.10% | ETF | Yes |
| VFQY | Vanguard U.S. Quality Factor ETF | $224M | -0.1% | 1.6% | 0.13% | ETF | Yes |
| VFMF | Vanguard U.S. Multifactor ETF | $168M | -0.4% | 1.9% | 0.18% | ETF | Yes |
| VCRB | Vanguard Core Bond ETF | $63M | -1.2% | 0% | 0.10% | ETF | Yes |
| VPLS | Vanguard Core Plus Bond ETF | $63M | -1.2% | 0% | 0.10% | ETF | Yes |
| VFVA | Vanguard U.S. Value Factor ETF | $589M | -2.5% | 2.7% | 0.13% | ETF | Yes |
In the end, Vanguard gets it. Despite being a leader in passive investing, sometimes active can be better. This is particularly true on the bond side. With that in mind, the passive pioneer has continued to adopt active ETFs across the space. Going forward, I suspect that the firm will launch more active funds covering different segments of the fixed income market.
The Bottom Line
Vanguard and passive investing go hand in hand. So, when the firm launches an active product, it’s a big deal. The firm’s latest active ETF launches underscore how active management in the fixed income space can drive real returns. In the end, it gives investors two additional tools to potentially outperform bond benchmarks.
1 Vanguard (January 2024). Actively managed funds
