WEBVTT - Vanguard’s Johnson on the Bond ETF Shift 0:00:15.160 --> 0:00:18.200 Welcome to Inside Active, a podcast about active managers that 0:00:18.239 --> 0:00:20.840 goes beyond sound bites and headlines and looks deeper into 0:00:20.840 --> 0:00:25.520 their processes, challenges and philosophies and security selection. I'm David Cohne, 0:00:25.560 --> 0:00:28.360 i lead mutual fund and active research at Bloomberg Intelligence. 0:00:28.880 --> 0:00:32.800 For years, ETFs were almost synonymous with passive investing, but 0:00:32.880 --> 0:00:35.320 one of the biggest shifts happening in the markets right 0:00:35.320 --> 0:00:38.000 now is the rise of active, particularly in fixed income, 0:00:38.360 --> 0:00:42.640 where inefficiencies, liquidity differences, and security selection can matter a 0:00:42.640 --> 0:00:46.239 lot more. At the same time, firms like Vanguard, historically 0:00:46.280 --> 0:00:49.760 synonymous with low cost indexing, are leading further into active 0:00:49.800 --> 0:00:54.200 strategies within the ETF wrapper, reflecting both investor behavior and 0:00:54.360 --> 0:00:59.000 portfolio construction are evolving. Soday, we're going to unpack with 0:00:59.160 --> 0:01:03.200 driving that shift across product design, investor behavior, and how 0:01:03.280 --> 0:01:06.759 active bond ETFs are actually being used. Joining me today 0:01:06.959 --> 0:01:09.760 today as my guest is Jeff Johnson, head of fixed 0:01:09.800 --> 0:01:14.240 income product at Vanguard. Jeff, thanks for joining me. Thanks David, 0:01:14.280 --> 0:01:16.720 it's great to be here. So let's start with the 0:01:16.720 --> 0:01:21.080 big picture. Vanguard historically you know, known with indexing. What 0:01:21.319 --> 0:01:25.120 role to active fixed income ETFs play in Vanguard's broader 0:01:25.240 --> 0:01:26.559 product philosophy today. 0:01:27.360 --> 0:01:29.959 That's great, That's a great place to start. And I 0:01:30.000 --> 0:01:34.280 think what I would say is that the conversation should 0:01:34.319 --> 0:01:37.160 still really start, in our view with what is the 0:01:37.280 --> 0:01:41.039 role of bonds in an investor's portfolio and getting that 0:01:41.360 --> 0:01:46.080 allocation right, and you know, the appropriate allocation to bonds, 0:01:46.120 --> 0:01:49.400 of course, as we all know, really depends from investor 0:01:49.440 --> 0:01:54.440 to investor based on their time horizon, risk tolerance goals, 0:01:55.520 --> 0:01:58.360 and in a variety of other needs that are very 0:01:58.360 --> 0:02:02.640 specific to the investor. And from there, many investors, as 0:02:02.680 --> 0:02:06.960 we know, have a real preference for active investing in 0:02:07.000 --> 0:02:10.120 their portfolio, given the size of the fixed income market, 0:02:10.160 --> 0:02:15.280 the complexity of the fixed income market, the thousands of securities, 0:02:15.360 --> 0:02:20.560 the opportunities that present from the various inefficiencies that exist 0:02:20.680 --> 0:02:24.600 in the fixed income market. Now for more than forty years, 0:02:24.720 --> 0:02:29.200 Vanguard has been providing that exposure to investors in the 0:02:29.240 --> 0:02:33.720 form of actively managed mutual funds, which have very clearly 0:02:33.840 --> 0:02:39.119 served investors very very well over the years. More recently, though, 0:02:39.160 --> 0:02:44.559 in recent decades, investors have increasingly shown a preference for ETFs. 0:02:45.000 --> 0:02:48.600 We first saw that really with the growth of ETFs 0:02:48.680 --> 0:02:54.080 in indexing oriented fixed income strategies, but more recently that 0:02:54.120 --> 0:02:57.040 has come together in the form of a broader array 0:02:57.200 --> 0:03:02.080 of actively managed fixed income ETF. So, from the standpoint 0:03:02.080 --> 0:03:06.280 of our investment philosophy, we're most concerned with getting investors 0:03:06.320 --> 0:03:10.520 the right allocation to fixed income first and foremost, and 0:03:10.560 --> 0:03:13.480 then from there it really comes down to a choice 0:03:13.919 --> 0:03:17.680 and a preference between indexing air active and then the 0:03:17.800 --> 0:03:21.640 vehicle that is most suitable to that particular investor, whether 0:03:21.680 --> 0:03:25.160 it be you know, traditionally a mutual fund or increasingly 0:03:25.200 --> 0:03:27.120 going forward in ETF. 0:03:27.440 --> 0:03:29.640 So how do you decide, you know, if you're thinking 0:03:29.680 --> 0:03:33.840 from product design and product launches which think that excuse me, 0:03:33.880 --> 0:03:37.680 fixed income strategies belonging an ETF wrapper versus mutual fund. 0:03:39.160 --> 0:03:43.280 This is a timely question. As I said, our mutual 0:03:43.280 --> 0:03:46.720 fund lineup in fixed income goes back more than forty years, 0:03:47.480 --> 0:03:51.280 and we still very much believe in those funds and 0:03:51.320 --> 0:03:55.920 strategies they serve investors incredibly well. We have, on average 0:03:56.520 --> 0:04:00.000 a ten basis point weighted expense ratio across our life 0:04:00.040 --> 0:04:04.640 lineup that compares to forty six basis points for the industry. 0:04:05.480 --> 0:04:09.320 Eighty eight percent of our funds have outperformed their peer 0:04:09.320 --> 0:04:12.320 group averages on a ten year basis, so we feel 0:04:12.320 --> 0:04:16.840 really great about the lineup when we are thinking about 0:04:16.960 --> 0:04:21.800 new product development. Though increasingly over the last couple of years, 0:04:21.839 --> 0:04:23.919 and this is probably going to continue to be the 0:04:23.960 --> 0:04:27.360 case going forward, the real preference and the real demand 0:04:27.440 --> 0:04:31.680 for investors has been for an ETF. We saw that 0:04:31.800 --> 0:04:35.279 first with index products. We're seeing that increasingly now on 0:04:35.360 --> 0:04:41.440 the actively managed side. Actively managed ETFs pose certain unique 0:04:41.680 --> 0:04:44.240 challenges that we have to consider in the development and 0:04:44.279 --> 0:04:49.360 the design process that are somewhat different from the issues 0:04:49.360 --> 0:04:52.440 that we've faced over the years with mutual funds. One 0:04:52.440 --> 0:04:56.919 of them has to do with the transparency and actively 0:04:56.960 --> 0:05:01.880 managed fixed income ETF discloses its full portfolio holdings on 0:05:01.960 --> 0:05:05.160 a daily basis, and what that means to us is 0:05:05.200 --> 0:05:09.120 in an active strategy, it's really important to ensure that 0:05:09.200 --> 0:05:14.080 the same sort of in some cases proprietary strategies designed 0:05:14.080 --> 0:05:19.320 to generate alpha or outperformance can persist in an actively 0:05:19.360 --> 0:05:26.320 managed ETF despite providing daily holdings transparency and potentially signaling 0:05:26.360 --> 0:05:29.960 to the marketplace what kind of trading activity the portfolio 0:05:30.040 --> 0:05:33.839 management teams are up to. So that is one area 0:05:34.000 --> 0:05:37.160 in which as we think about the design of actively 0:05:37.200 --> 0:05:41.600 managed fixed income ETFs, at times there are certain modifications 0:05:41.600 --> 0:05:44.400 that we have to make to the portfolio or the 0:05:44.480 --> 0:05:48.320 process to accommodate that and still ensure that we're delivering 0:05:48.640 --> 0:05:53.080 top notch investment outcomes and the exposures that investors expect 0:05:53.120 --> 0:05:56.960 in a given strategy. Another aspect, and probably the second 0:05:57.000 --> 0:06:00.480 aspect that would that I would call out that is 0:06:00.520 --> 0:06:03.200 really important for us to think about in active fixed 0:06:03.240 --> 0:06:08.560 income ETFs is size and scalability and capacity. At Vanguard, 0:06:08.600 --> 0:06:11.680 we're very proud to serve tens of millions of investors, 0:06:12.360 --> 0:06:16.360 but with that comes the obligation to really think about 0:06:17.120 --> 0:06:20.839 how scalable are these strategies going to be. It's sort 0:06:20.839 --> 0:06:22.799 of been a good problem to have in the past 0:06:22.800 --> 0:06:26.200 that we've had to at times close certain funds because 0:06:26.200 --> 0:06:31.200 we need to preserve the manager's underlying ability to generate alpha, 0:06:31.720 --> 0:06:36.039 and as you and your listeners would know, sometimes large 0:06:36.040 --> 0:06:39.279 cash flows are large size can be an impediment to 0:06:39.720 --> 0:06:41.719 generating the same sort of ALP that you have in 0:06:41.760 --> 0:06:46.760 the past. So anytime we're thinking about an actively managed product, 0:06:46.839 --> 0:06:51.080 we do have to think about how scalable it will 0:06:51.120 --> 0:06:53.599 be and ensure that we're not going to run into 0:06:53.720 --> 0:06:56.120 near term capacity constraints. 0:06:57.040 --> 0:06:59.560 Yeah, definitely something I like to think about a lot, 0:06:59.600 --> 0:07:02.280 you know, looking at neutral funds versus ETFs. That's kind 0:07:02.279 --> 0:07:04.160 of like the big I think the more in the 0:07:04.160 --> 0:07:06.360 equity side, you know, where capacity is an issue, but 0:07:06.600 --> 0:07:09.159 your crag to fixed incum is also something to think about. 0:07:09.800 --> 0:07:13.400 And you know, Bakers launched several active fixed income ETFs 0:07:13.440 --> 0:07:18.080 in recent years. What gap and client portfolios were were 0:07:18.080 --> 0:07:20.000 you're trying to solve for and you know, and think 0:07:20.000 --> 0:07:22.160 about continuing to solve for going forward. 0:07:22.440 --> 0:07:25.040 Yeah, I think of this not so much as a 0:07:25.120 --> 0:07:30.040 gap in client portfolios as an opportunity and a trend 0:07:30.120 --> 0:07:35.480 that it was time for Vanguard to participate in. You know, 0:07:36.720 --> 0:07:39.880 our first actively managed fixed income ETF was launched in 0:07:39.960 --> 0:07:44.760 twenty twenty one, that was the Vanguard Ultra Short Bond ETF. 0:07:45.200 --> 0:07:48.640 And a few years went by before we began to 0:07:48.800 --> 0:07:53.360 rapidly expand our lineup. And I think, in fact, David, 0:07:53.400 --> 0:07:56.600 one of your colleagues at times, has liked to joke 0:07:56.720 --> 0:08:02.120 that launching product Banguard is sort of like observing a 0:08:02.200 --> 0:08:05.840 lunar eclipse because it happens so rarely. And I think 0:08:05.880 --> 0:08:07.800 over the last few years, it's been fair to push 0:08:07.880 --> 0:08:09.720 back on that a little bit and maybe say that 0:08:10.000 --> 0:08:13.080 it's maybe more akin to like the cycle of a 0:08:13.120 --> 0:08:15.760 full moon, because we've been a little bit more active 0:08:15.880 --> 0:08:20.560 launching active products. We've launched eight in the last two 0:08:20.560 --> 0:08:25.400 and a half years. And you know, that really came 0:08:25.520 --> 0:08:29.040 from a sort of a clear observance of a few 0:08:29.120 --> 0:08:32.959 trends coming together. One, we've long known that investors have 0:08:33.000 --> 0:08:36.199 a preference or a bias for being active in their 0:08:36.240 --> 0:08:39.839 fixed income portfolios. There's no doubt been a growth of indexing, 0:08:40.280 --> 0:08:43.000 but it is still an asset class where the abundant 0:08:43.320 --> 0:08:47.120 the opportunities are pretty abundant for very skilled active managers. 0:08:48.000 --> 0:08:50.440 The other trend that was pretty clear is the increasing 0:08:50.559 --> 0:08:56.400 preference for the ETFs as a vehicle in ETFs as 0:08:56.440 --> 0:09:00.280 the wrapper for the product. And as we saw these 0:09:00.280 --> 0:09:05.920 real trends converging and reflected on our deep expertise and 0:09:06.040 --> 0:09:10.920 capabilities managing ETFs, married with our more than forty years 0:09:10.920 --> 0:09:14.880 of history managing active fixed income very successfully, we felt 0:09:14.920 --> 0:09:17.280 it was really time to bring the Vanguard effect to 0:09:17.400 --> 0:09:20.440 active fixed income ETFs. And as we set out on 0:09:20.480 --> 0:09:24.360 that journey, really had the opportunity to kind of blank slate, 0:09:24.440 --> 0:09:27.120 look at the market and say, all right, what kind 0:09:27.160 --> 0:09:32.440 of products, what kind of strategies are investors most gravitating towards? 0:09:32.480 --> 0:09:36.080 How have their needs evolved? And we've really concentrated our 0:09:36.080 --> 0:09:41.520 efforts in two areas. On the taxable fixed income side, 0:09:42.160 --> 0:09:45.720 there are a handful of very core building blocks that 0:09:45.880 --> 0:09:51.200 investors are increasingly utilizing in their portfolios. When they show 0:09:51.240 --> 0:09:54.800 that preference for active management, you know, they like short 0:09:54.880 --> 0:09:59.280 duration strategies to be able to minimize the exposure to 0:10:00.280 --> 0:10:02.920 changes in interest rates. So we launched a short duration 0:10:03.280 --> 0:10:08.400 core product. Investors continue to look for core and core 0:10:08.480 --> 0:10:12.760 plus fixed income strategies for those that are looking for 0:10:12.800 --> 0:10:17.079 an active alternative to an aggregate type benchmark, or an 0:10:17.120 --> 0:10:21.240 active alternative with some higher yielding sectors like like would 0:10:21.240 --> 0:10:24.160 be in the case in a core plus. We felt 0:10:24.240 --> 0:10:29.559 it was really important to offer exposures active investors, exposures 0:10:29.600 --> 0:10:33.800 to active government securities. You know, there are times when 0:10:33.880 --> 0:10:36.439 investors are more interested in yield, but there's also times 0:10:36.440 --> 0:10:39.440 when it really pays off to have that high quality, 0:10:39.600 --> 0:10:43.480 very liquid fixed income ballast in the portfolio. And we're 0:10:43.520 --> 0:10:47.199 offering that now in the form of a government active ETF. 0:10:47.800 --> 0:10:49.560 And then for those investors who are looking to go 0:10:49.640 --> 0:10:53.160 farther out on the risk spectrum, high yield and multisector 0:10:53.240 --> 0:10:56.560 can be strategies that offer more of that income focus. 0:10:57.440 --> 0:11:00.160 And then the second key category that we've seen is 0:11:00.160 --> 0:11:04.880 on the muni side, where we know that investors are 0:11:05.000 --> 0:11:10.760 very interested in controlling their tax obligations, and Vanguard has 0:11:10.800 --> 0:11:15.320 long been a leading provider of municipal bond funds. So 0:11:15.480 --> 0:11:18.800 offering a short duration and a core muni strategy really, 0:11:18.840 --> 0:11:22.520 at least at this phase one of our product build out, 0:11:23.080 --> 0:11:26.520 really completes the steps that makes sense. 0:11:27.160 --> 0:11:30.319 You know, we're seeing really strong growth in active ETFs 0:11:30.320 --> 0:11:35.360 across all asset classes. Why is fixed income in particular, 0:11:36.000 --> 0:11:39.000 in your opinion, such fertile ground for active management in 0:11:39.040 --> 0:11:39.560 this wrapper. 0:11:42.600 --> 0:11:44.480 I think this gets back to something that we were 0:11:44.480 --> 0:11:48.480 describing earlier. The market is so broad. There are about 0:11:48.520 --> 0:11:54.720 fourteen thousand securities in the aggregate index. There are opportunities 0:11:54.760 --> 0:12:00.200 for skilled managers to uncover value with disciplined processing these. 0:12:00.920 --> 0:12:04.640 There certainly are still cases in the fixed income markets 0:12:04.760 --> 0:12:07.679 where bonds are less liquid. It's long been said that 0:12:07.720 --> 0:12:10.720 certain types of bonds trade by appointment only that that 0:12:10.880 --> 0:12:13.920 is still the case despite you know what's been you know, 0:12:14.440 --> 0:12:18.559 phenomenal growth in terms of electronic trading and optimization and 0:12:18.840 --> 0:12:24.120 automization in fixed income markets. Another factor that we can't 0:12:24.160 --> 0:12:28.400 ignore here, though, is that ETFs is a relatively new 0:12:28.480 --> 0:12:32.160 technology still. You know, I think for some investors, we're 0:12:32.200 --> 0:12:37.000 looking for ETFs to prove that they could withstand a crisis, 0:12:37.679 --> 0:12:41.880 for ETFs to prove that they could really weather a storm, 0:12:42.520 --> 0:12:46.160 and they really did so with flying colors in twenty 0:12:46.240 --> 0:12:51.120 twenty again in twenty twenty two, when we saw significant 0:12:51.120 --> 0:12:55.080 amounts of market volatility in both market environments. I think 0:12:55.120 --> 0:12:58.160 it really gave investors a lot of confidence that even 0:12:58.200 --> 0:13:01.079 though this is a vehicle where certain of underlying securities 0:13:01.080 --> 0:13:05.160 can sometimes be less liquid, the liquidity of the overall 0:13:05.200 --> 0:13:09.000 wrapper has proven to be extremely effective. So I think 0:13:09.000 --> 0:13:12.920 that's given investors a lot of confidence and fueled substantial 0:13:12.960 --> 0:13:16.400 amounts of growth for fixed income ETFs. 0:13:16.720 --> 0:13:20.120 Okay, do you think active bond ETFs are gaining share 0:13:20.160 --> 0:13:26.560 because of performance, transparency, tax efficiency, or advisor adoption or 0:13:26.600 --> 0:13:29.280 some combination of the previous ones. 0:13:30.360 --> 0:13:32.440 Well, David, I think the answer is all of the above. 0:13:32.760 --> 0:13:40.160 I think investors are are increasingly adopting active fixeding come 0:13:40.240 --> 0:13:45.520 ETFs because they appreciate the transparency, They appreciate the liquidity, 0:13:46.200 --> 0:13:50.640 they appreciate the increasing array of choice that they have 0:13:50.840 --> 0:13:55.200 in terms of product design and offerings. I think, you know, 0:13:55.280 --> 0:14:00.000 while active ETFs, you know, still carry a slightly higher 0:14:00.000 --> 0:14:04.760 expense ratio than index ETFs, buy and large active ETFs 0:14:04.760 --> 0:14:06.920 have come to the market at a at a bit 0:14:06.960 --> 0:14:10.880 more of an attractive price point than actively managed funds. 0:14:10.880 --> 0:14:14.080 More and more investors are really appreciating, you know, what 0:14:14.200 --> 0:14:18.480 Vanguard has long espoused in terms of you really get 0:14:18.480 --> 0:14:20.920 what you don't pay for when it comes to investing in. 0:14:21.000 --> 0:14:23.160 The lower expense ratio means that you get to keep 0:14:23.200 --> 0:14:26.920 more of that return for yourself. The flexibility and the 0:14:26.960 --> 0:14:29.880 liquidity again, those are just all features that investors are 0:14:29.880 --> 0:14:34.040 increasingly gravitating towards. And we really don't see that slowing 0:14:34.040 --> 0:14:34.960 down anytime soon. 0:14:35.160 --> 0:14:38.360 So if we think from five years from now, what 0:14:38.480 --> 0:14:41.520 percentage of Vanguard's fixed income ETF assets do you think 0:14:41.560 --> 0:14:44.040 will be active? Oh? 0:14:44.080 --> 0:14:48.920 Man, I would have a hard time putting a number 0:14:48.960 --> 0:14:51.200 on that figure. I think, you know, when we look 0:14:51.280 --> 0:14:54.760 though at what we saw in twenty twenty five, that's 0:14:54.800 --> 0:14:57.880 probably fairly indicative of where the industry is headed. There 0:14:57.880 --> 0:15:02.160 were about six hundred billion dollars in flows into fixed 0:15:02.240 --> 0:15:06.280 income in twenty twenty five, and that was pretty evenly 0:15:06.360 --> 0:15:11.320 split between index and active, but roughly seventy percent of 0:15:11.360 --> 0:15:16.080 the flows were into ETFs, So it is increasingly the 0:15:16.360 --> 0:15:19.840 vehicle of choice. So I would expect our share of 0:15:20.200 --> 0:15:24.360 ETFs as in terms of vanguards overall fixing umbiga business 0:15:24.360 --> 0:15:25.360 to continue to climb. 0:15:25.960 --> 0:15:28.600 Okay, And you know, if we think about right now 0:15:28.720 --> 0:15:31.160 fixed income, right now, where do you where are you 0:15:31.200 --> 0:15:34.600 seeing cash flow going in terms of the fixed income 0:15:34.680 --> 0:15:38.000 market ultra short core munis. 0:15:38.480 --> 0:15:40.720 There have been some important shifts here over the last 0:15:40.720 --> 0:15:42.920 few years. I think kind of have to start the 0:15:42.960 --> 0:15:45.760 conversation in some ways with what happened in twenty twenty 0:15:45.800 --> 0:15:50.560 two and twenty twenty three. Investors were very much you know, 0:15:50.560 --> 0:15:56.080 I think, startled by rapid moves and interest rates inflation, 0:15:56.800 --> 0:15:59.520 and they saw declines on bond market benchmarks that they 0:15:59.520 --> 0:16:01.640 weren't a customed to seeing. It had been you know, 0:16:01.720 --> 0:16:04.360 decades since they had seen those sorts of losses in 0:16:04.440 --> 0:16:08.400 fixed income. The good news there was by and large 0:16:08.400 --> 0:16:12.520 and vanguard investors were very well behaved. I think we've 0:16:12.520 --> 0:16:15.560 all always done a pretty good job of attracting investors 0:16:15.600 --> 0:16:19.600 who buy into our investment philosophy, our investment principles around 0:16:20.680 --> 0:16:25.920 you know, having clear goals, being balanced, being disciplined, focusing 0:16:25.960 --> 0:16:29.680 on low costs. So they took the volatility in stride. 0:16:29.800 --> 0:16:32.440 That all said, I think we saw a lot of 0:16:32.440 --> 0:16:34.600 the same trends that the rest of the industry saw, 0:16:34.640 --> 0:16:38.920 which was investors favoring shorter duration strategies, a lot of 0:16:38.960 --> 0:16:43.640 cash oriented strategies in recent years, and this was definitely 0:16:43.720 --> 0:16:47.080 the case in twenty twenty five, and it persists. Investors 0:16:47.160 --> 0:16:51.240 have been creeping out the curve and they've been looking 0:16:51.280 --> 0:16:54.760 to take on more risk and generate more income and 0:16:54.840 --> 0:16:58.000 yield in their portfolios, and the opportunity has really been 0:16:58.120 --> 0:17:03.840 ripe for that. In the active fixed income category, a 0:17:03.920 --> 0:17:08.479 lot of demand for core, core, plus and multi sector 0:17:09.040 --> 0:17:13.440 type strategies. And some of that speaks to the real 0:17:13.480 --> 0:17:17.480 appreciation that investors seem to have in active fixed income 0:17:17.600 --> 0:17:23.679 for intrusting very talented, skilled managers with the flexibility to 0:17:23.720 --> 0:17:27.840 move across sectors and identify value where their teams see 0:17:27.880 --> 0:17:31.040 the greatest amount of opportunity, and I would contrast that 0:17:31.080 --> 0:17:35.399 somewhat with what we see in index fixed income flows, 0:17:35.440 --> 0:17:38.800 which is probably more broad based demand and in some 0:17:38.880 --> 0:17:43.439 cases investors looking for indices to target more narrow exposures 0:17:43.480 --> 0:17:45.040 and get their beta exposure that way. 0:17:46.040 --> 0:17:48.280 So you think, you know things have changed, is the 0:17:48.359 --> 0:17:51.360 rate shock of twenty twenty two, and you're seeing investors 0:17:51.480 --> 0:17:54.280 extending duration again, we. 0:17:54.240 --> 0:17:56.840 Are seeing that, we're seeing them extend duration. We're seeing 0:17:56.840 --> 0:18:00.399 them look to you know, corporate and higher US yielding 0:18:00.440 --> 0:18:03.520 sectors to pick up yield. You know, I would I 0:18:03.520 --> 0:18:07.679 would remind them that the market environment is still one 0:18:07.760 --> 0:18:11.399 that is characterized by a great deal of uncertainty. Uh. 0:18:11.640 --> 0:18:16.000 You know, there's certainly uncertainty from a geopolitical standpoint. We're 0:18:16.040 --> 0:18:18.879 going to be going through a transition of leadership at 0:18:19.160 --> 0:18:23.040 the Federal Reserve. You know, inflation is still very much 0:18:23.040 --> 0:18:26.760 on people's minds. Be our word has crept in more 0:18:26.840 --> 0:18:30.399 recently as as you know, tensions in the Middle East 0:18:30.440 --> 0:18:34.200 have have escalated. So, you know, while we still see 0:18:34.359 --> 0:18:39.400 attractive opportunities in in core plus and higher yield type sectors, 0:18:40.160 --> 0:18:43.480 but still remind investors that government bonds, you know, inflation 0:18:43.600 --> 0:18:45.960 linked bonds can play a real role in their portfolio 0:18:46.000 --> 0:18:49.280 from a diversification standpoint, and can come in real handy 0:18:49.960 --> 0:18:53.280 if we do see periods of increased volatility. 0:18:54.359 --> 0:18:57.760 What role do you think active bond ETFs are playing 0:18:57.800 --> 0:19:00.560 in model portfolios today compared to I don't know, like 0:19:00.560 --> 0:19:01.280 three years ago. 0:19:04.280 --> 0:19:08.520 Yeah, model model portfolios are UH, you know, very much 0:19:08.520 --> 0:19:15.320 a growth engine, particularly in the financial advisor space. UH 0:19:15.400 --> 0:19:19.760 and and models have been a driving force behind the 0:19:19.800 --> 0:19:24.080 adoption of fixed income indexing ETFs, in part because a 0:19:24.080 --> 0:19:28.159 lot of advisors are looking for very specific exposures UH 0:19:28.320 --> 0:19:32.360 to UH sectors of the fixed income market, whether it's 0:19:32.359 --> 0:19:38.560 short duration, long duration, corporate treasury, mortgages, high yield. So, 0:19:38.960 --> 0:19:41.880 you know, indexed et s within model portfolios have been 0:19:42.359 --> 0:19:46.960 a very effective tool for advisors to be active with 0:19:47.040 --> 0:19:51.520 their acid allocation, but sometimes deploy those those views in 0:19:51.560 --> 0:19:54.800 a passive way through a through an indexed vehicle. What 0:19:54.920 --> 0:19:58.080 we're seeing on the on the active et F side, though, 0:19:58.200 --> 0:20:02.200 are are UH the ability for advisors to build model 0:20:02.200 --> 0:20:05.560 portfolios that capture sort of the breadth of a team's 0:20:05.840 --> 0:20:09.280 best ideas in an active ETF. So we see, you know, 0:20:09.359 --> 0:20:13.960 real growth for strategies in particular like core bond or 0:20:14.000 --> 0:20:17.159 coreplus bond active ETFs, which tend to be a very 0:20:17.200 --> 0:20:20.760 strategic and core element of ETF models. 0:20:21.480 --> 0:20:24.520 If we go beyond model portfolios and think of advisors 0:20:24.560 --> 0:20:27.520 that are doing, you know, selection on their own, are 0:20:27.560 --> 0:20:31.199 you seeing them use active bond ETFs differently than index 0:20:31.280 --> 0:20:32.040 bond ETFs. 0:20:33.560 --> 0:20:36.040 There are some nuanced differences here, And as we've kind 0:20:36.040 --> 0:20:38.040 of talked about a little bit already or alluded to, 0:20:40.080 --> 0:20:42.359 I think it's long been the case that investors have 0:20:42.440 --> 0:20:46.960 a bias in fixed income towards being active because of 0:20:47.000 --> 0:20:50.120 the opportunities and the inefficiencies, and the breadth and complexity 0:20:50.680 --> 0:20:53.320 of the market. And it was only just in twenty 0:20:53.359 --> 0:20:58.400 twenty five that index flows were about on par with 0:20:58.400 --> 0:21:02.359 with active flows across the intry. For twenty five years, 0:21:02.359 --> 0:21:05.720 I've been in and around fixed income markets, spoken to 0:21:05.760 --> 0:21:08.200 a lot of investors, spoken to a lot of clients. 0:21:08.680 --> 0:21:12.360 I haven't met too many fixed income investors who are 0:21:12.760 --> 0:21:19.199 purely passive. Most fixed income investors are active at a 0:21:19.200 --> 0:21:21.800 minimum when it comes to setting the acid allocation. They're 0:21:21.840 --> 0:21:26.000 thinking about what are their unique goals, what's their time horizon, 0:21:26.680 --> 0:21:30.480 How important is liquidity in their portfolio. How comfortable are 0:21:30.520 --> 0:21:34.280 they going down the credit quality spectrum in picking up 0:21:34.600 --> 0:21:39.720 additional yield? Our taxes important to them are not. These 0:21:39.720 --> 0:21:43.639 are all very very active decisions that a fixed income 0:21:43.840 --> 0:21:48.800 acid allocator must weight make when building their portfolio. And 0:21:48.880 --> 0:21:52.240 the great news for them that's emerged over the last 0:21:52.320 --> 0:21:54.960 ten years or so is that they have an incredible 0:21:55.000 --> 0:21:57.880 amount of choice now if they want to be very 0:21:57.920 --> 0:22:01.160 active with that decision making. From an acid out location standpoint, 0:22:01.520 --> 0:22:06.639 they have an abundance of tools that allow them to 0:22:06.640 --> 0:22:12.399 position a portfolio and deploy their views actively but potentially 0:22:12.480 --> 0:22:18.280 using underlying index vehicles that track those benchmarks that reflect 0:22:18.320 --> 0:22:22.440 their active points of view. In other cases, we continue 0:22:22.440 --> 0:22:26.240 to see fixed income investors looking to active managers to 0:22:26.560 --> 0:22:30.880 scan the universe and look for the best opportunities capitalize 0:22:30.880 --> 0:22:34.480 on the value that's available, and increasingly what we're seeing 0:22:34.560 --> 0:22:38.040 is that they're showing a preference in active vehicles towards 0:22:38.080 --> 0:22:41.879 the broader, more flexible fixed income strategies that give the 0:22:41.920 --> 0:22:45.640 managers the latitude to move across investment grade or high 0:22:45.720 --> 0:22:50.000 yield or emerging markets or in some cases currencies, maybe mortgages, 0:22:50.520 --> 0:22:55.320 securit tights securitize sectors to find the best value wherever 0:22:55.400 --> 0:22:56.760 it exists at that point in time. 0:22:58.280 --> 0:22:59.560 So I kind of want to go a little deeper. 0:23:00.080 --> 0:23:02.560 You know, yields are obviously meaningful higher than they were. 0:23:02.640 --> 0:23:05.040 I don't like a decade ago. Do you think the 0:23:05.040 --> 0:23:09.239 conversations changed about you know, taking credit risk for you know, 0:23:09.680 --> 0:23:11.920 whether it's advisors or individual investors. 0:23:14.600 --> 0:23:19.160 Well, you're right, yields. Yields are higher, and higher yields 0:23:19.200 --> 0:23:22.600 have changed the conversation a little bit that we're able 0:23:22.640 --> 0:23:26.400 to have with investors. You know, it wasn't too long 0:23:26.440 --> 0:23:30.840 ago that investors were you know, pretty you know, pretty 0:23:30.840 --> 0:23:33.119 bothered by the very low yield environment. There wasn't a 0:23:33.119 --> 0:23:36.640 lot of income available that has has no doubt changed. 0:23:36.840 --> 0:23:41.399 It's changed so much, in fact, that Vanguard's own longer 0:23:41.480 --> 0:23:46.360 term economic outlook has you know, fairly comparable expected returns 0:23:46.400 --> 0:23:49.720 between stocks and bonds. This is an environment where you know, 0:23:49.760 --> 0:23:52.560 we think investors at least need to be thinking about 0:23:52.600 --> 0:23:56.800 a sixty forty portfolio, if not forty sixty. And that's 0:23:56.840 --> 0:23:59.520 especially the case in the market environment like we have today, 0:23:59.560 --> 0:24:01.920 when they're is you know a great deal of uncertainty 0:24:02.320 --> 0:24:07.280 and we've seen increases in volatility. Some investors are still 0:24:07.320 --> 0:24:11.200 nervous about what could happen if rates rise or if 0:24:11.240 --> 0:24:14.119 you do get in inflation shock. But the good news 0:24:14.200 --> 0:24:17.560 is is that when you have a core strategy that's 0:24:17.640 --> 0:24:21.359 yielding upwards of four percent, you do have a built 0:24:21.359 --> 0:24:23.520 in yield cushion, so that if yields do go up 0:24:23.520 --> 0:24:26.080 from here, the good news is that you're going to 0:24:26.080 --> 0:24:28.440 be earning higher yields from here. The other good news 0:24:28.480 --> 0:24:31.199 is that you know that higher yield that you're starting 0:24:31.200 --> 0:24:33.160 out with provides a little bit of a buffer from 0:24:33.200 --> 0:24:37.480 any sort of capital losses that take place in the 0:24:37.480 --> 0:24:38.640 shorter term. 0:24:39.520 --> 0:24:43.960 So the fixedick and ETF ecosystem has evolved pretty rapidly. 0:24:44.359 --> 0:24:47.000 How do you think about liquidity and active bond ETF, 0:24:47.200 --> 0:24:49.360 especially in less liquid sectors. 0:24:52.960 --> 0:24:55.360 You know, really, we think about it very similarly as 0:24:55.359 --> 0:25:00.280 we do thinking about liquidity in are actively managed fixed 0:25:00.320 --> 0:25:06.720 income mutual funds. These are all broadly diversified strategies. We 0:25:06.800 --> 0:25:09.800 have a liquidity framework and a toolkit for all of 0:25:09.800 --> 0:25:14.640 our active strategies. We're very disciplined about maintaining dry powder 0:25:15.119 --> 0:25:19.200 in these portfolios to help ensure that the managers always 0:25:19.240 --> 0:25:23.800 have the flexibility to take advantage of opportunities when the 0:25:23.880 --> 0:25:29.399 market presents them. I think the experience that Vanguard has 0:25:29.440 --> 0:25:33.800 going back decades managing ETFs on the index side has 0:25:33.840 --> 0:25:38.680 allowed us to build out years and years of technology 0:25:39.280 --> 0:25:45.880 and expertise and experience through different cycles managing ETFs, developing 0:25:45.920 --> 0:25:51.520 that ecosystem, developing a capital markets ecosystem. I think this 0:25:51.720 --> 0:25:57.800 combination of our active history, our index history, and our 0:25:58.760 --> 0:26:05.119 ETF history kind of provides a unique combination and value 0:26:05.119 --> 0:26:08.159 proposition to investors looking for kind of the best of 0:26:08.200 --> 0:26:11.080 all of those things in active fixed income ETFs. 0:26:11.320 --> 0:26:16.040 Okay, and what differentiates Vanguard's approach to active fixed income 0:26:16.040 --> 0:26:19.960 ETFs from peers who may want to emphasize things like 0:26:20.040 --> 0:26:22.600