Partner Insight: Vanguard - Navigating global credit markets in a downturn

As corporate bond investors face the growing likelihood of recession and the resulting volatility, the depth and breadth of the slowdown in growth will play a meaningful role in determining the trajectory of global credit markets. 

While a soft landing would likely be the most favourable scenario for credit markets, the signs of weakening growth in most economies suggest such a benign outcome is increasingly unlikely. This is raising concerns about how an economic slowdown will affect the day-to-day operations of corporate bond issuers—and in turn, their creditworthiness—under tighter financial conditions. 

For most of 2023, global credit markets have been pricing in a soft landing as both growth and inflation moderated from their cyclical highs. Yet as the economic climate continues to weaken, corporate bond performance is likely to be more sensitive to the impact that a slowdown will have on corporate fundamentals. 

Here, Vanguard's active credit team share their views on what they believe is the best approach to creating long-term value from active credit and how to prepare investor portfolios for what lies ahead. 

The importance of security selection

An economic downturn can present a range of challenges for corporate bond issuers. Weaker demand, for example, can make it difficult for companies to pass along higher costs through price rises to their customers - putting pressure on margins and squeezing cash flows. For those with maturing debt, the shock of significantly higher refinancing costs in the current interest rate environment may add additional stress to corporate balance sheets. 

For example, as recent slowing economic activity in Europe has started to impact sectors such as basic materials, industrials and consumer discretionary, this has opened up a number of attractive selection opportunities, particularly among European BBB-rated industrials issuers.

When we consider the hurdles facing corporate issuers, and the potential volatility and dispersion they can create in credit markets, an active management approach with a focus on credit security selection is even more vital. 

By focusing on the fundamentals of individual issuers, conducting thorough credit analysis and building portfolios using diversified sources of alpha, active credit strategies with a bottom-up approach to security selection can help investors mitigate their exposure to broad market swings while capitalising on idiosyncratic return opportunities when they occur. 

Diversified alpha, not leveraged beta

Some active credit funds take excessive bets on the direction of bond markets to generate returns, often referred to as a ‘levered beta' approach. Yet strategies that rely on levered beta to generate excess returns, especially in more volatile environments, tend to have a low probability of success over the long term. 

Rather than relying on top-down, directional or correlated risk positions to generate returns, investors should look for active credit managers that efficiently construct their portfolios to provide the best active returns relative to the risk incurred, with a focus on idiosyncratic opportunities that can help diversify risk regardless of market conditions.   

Such opportunities do not just come from choosing the right issuers in each sector. They can also arise from selecting the right currency in which to gain exposure to a given issuer and the optimal point on the yield curve, as well as other considerations, such as weighing up the relative merits of senior versus subordinated bonds and whether to use cash or other instruments to implement positions. Opportunities are therefore plentiful - and not dependent on the direction of markets. 

Low costs: An asymmetric advantage 

For investors, the impact of lower fees on long-term returns is well-established1. What is less well understood is how lower costs can play a role in an active credit fund's investment strategy and performance. 

Active funds with lower expense ratios like the Vanguard Global Credit Bond Fund have an asymmetric advantage: the fund's low fees and global scale mean its managers aren't under the same pressure to maintain a certain level of risk to offset their costs to investors. As a result, Vanguard's fund managers can be more opportunistic in their approach, holding back when markets look overvalued and taking positions when dislocations occur and opportunities arise.  

A 'true-to-label' approach 

When markets are volatile, investors in active credit may want to focus on fund managers with a ‘true-to-label' track record - those which have consistently delivered alpha at an equivalent level of risk to their benchmark. 

Importantly, funds that derive alpha from a diverse range of securities can be better equipped to deliver a more consistent stream of returns in all market environments. This contrasts with ‘levered beta' strategies, which rely on taking correctly timed, directional bets on market movements to generate additional returns.

Funds like the Vanguard Global Credit Bond Fund can add a diversified layer of credit exposure to investors' fixed income portfolios, with the aim of providing a more consistent level of risk-adjusted returns while avoiding additional risk when economic and market conditions are shifting. 

The Vanguard Global Corporate Bond Fund was recently awarded the Gold Medalist Rating by Morningstar, based on its strong management team and risk-adjusted approach, backed by the consistency and reputation of Vanguard. 

1 ‘The case for low-cost index-fund investing', Vanguard research, May 2023. 

Important risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Some funds invest in emerging markets which can be more volatile than more established markets. As a result the value of your investment may rise or fall.

Investments in smaller companies may be more volatile than investments in well-established blue chip companies.

Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.

The Vanguard Global Credit Bond Fund may use derivatives, including for investment purposes, in order to reduce risk or cost and/or generate extra income or growth. For all other funds they will be used to reduce risk or cost and/or generate extra income or growth. The use of derivatives could increase or reduce exposure to underlying assets and result in greater fluctuations of the Funds net asset value. A derivative is a financial contract whose value is based on the value of a financial asset (such as a share, bond, or currency) or a market index.

Some funds invest in securities which are denominated in different currencies. Movements in currency exchange rates can affect the return of investments.

For further information on risks please see the "Risk Factors" section of the prospectus.

Important Information

This is a marketing communication.

For professional investors only (as defined under the MiFID II Directive) investing for their own account (including management companies (fund of funds) and professional clients investing on behalf of their discretionary clients). In Switzerland for professional investors only. Not to be distributed to the public.

For further information on the fund's investment policies and risks, please refer to the prospectus of the UCITS and to the KIID (for UK, Channel Islands, Isle of Man investors) and to the KID (for European investors) before making any final investment decisions. The KIID and KID for this fund are available in local languages, alongside the prospectus via Vanguard's website.

The information contained herein is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information is general in nature and does not constitute legal, tax, or investment advice. Potential investors are urged to consult their professional advisers on the implications of making an investment in, holding or disposing of shares and /or units of, and the receipt of distribution from any investment.

For Swiss professional investors: Potential investors will not benefit from the protection of the FinSA on assessing appropriateness and suitability.

Vanguard Investment Series plc has been authorised by the Central Bank of Ireland as a UCITS and has been registered for public distribution in certain EEA countries and the UK. Prospective investors are referred to the  Funds' prospectus for further information. Prospective investors are also urged to consult their own professional advisers on the implications of making an investment in, and holding or disposing shares of the Funds and the receipt of distributions with respect to such shares under the law of the countries in which they are liable to taxation.

The Manager of Vanguard Investment Series plc is Vanguard Group (Ireland) Limited. Vanguard Asset Management, Limited is a distributor of Vanguard Investment Series plc.

For Swiss professional investors: The Manager of Vanguard Investment Series plc is Vanguard Group (Ireland) Limited. Vanguard Investments Switzerland GmbH is a financial services provider, providing services in the form of purchase and sales according to Art. 3 (c)(1) FinSA . Vanguard Investments Switzerland GmbH will not perform any appropriateness or suitability assessment. Furthermore, Vanguard Investments Switzerland GmbH does not provide any services in the form of advice. Vanguard Investment Series plc has been authorised by the Central Bank of Ireland as a UCITS. Prospective investors are referred to the Funds' prospectus for further information. Prospective investors are also urged to consult their own professional advisors on the implications of making an investment in, and holding or disposing shares of the Funds and the receipt of distributions with respect to such shares under the law of the countries in which they are liable to taxation.

For Swiss professional investors: Vanguard Investment Series plc has been approved for offer in Switzerland by the Swiss Financial Market Supervisory Authority (FINMA). The information provided herein does not constitute an offer of Vanguard Investment Series plc in Switzerland pursuant to FinSA and its implementing ordinance. This is solely an advertisement pursuant to FinSA and its implementing ordinance for Vanguard Investment Series plc. The Representative and the Paying Agent in Switzerland is BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich. Copies of the Articles of Incorporation, KID, Prospectus, Declaration of Trust, By-Laws, Annual Report and Semiannual Report for these funds can be obtained free of charge from the Swiss Representative or from Vanguard Investments Switzerland GmbH via our website.

The Manager of the Ireland domiciled funds may determine to terminate any arrangements made for marketing the shares in one or more jurisdictions in accordance with the UCITS Directive, as may be amended from time-to-time.

For investors in Ireland domiciled funds, a summary of investor rights is available in English, German, French, Spanish, Dutch and Italian.

For Dutch investors only: The fund(s) referred to herein are listed in the AFM register as defined in section 1:107 Dutch Financial Supervision Act (Wet op het financieel toezicht). For details of the Risk indicator for each fund listed, please see the fact sheet(s).

Issued in EEA by Vanguard Group (Ireland) Limited which is regulated in Ireland by the Central Bank of Ireland.
Issued in Switzerland by Vanguard Investments Switzerland GmbH.
Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.

© 2023 Vanguard Group (Ireland) Limited. All rights reserved. 
© 2023 Vanguard Investments Switzerland GmbH. All rights reserved. 
© 2023 Vanguard Asset Management, Limited. All rights reserved.