Conventional wisdom holds that indexing works best in heavily researched categories, such as large-cap U.S. stocks, in which it’s hard for fund managers to gain an edge. By contrast, actively run funds should, in theory, shine in more-obscure classes, such as emerging-markets bonds. Vanguard Emerging Markets Government Bond Index Fund (VGAVX) has defied this commonly held view, outpacing 93% of emerging-markets debt funds since its launch in 2013.
The fund tracks an index of dollar-denominated bonds issued by governments and government-linked firms (think Brazil’s Petrobras). It has benefited from holding issues with long maturities and low credit ratings. The portfolio’s average duration (a measure of interest-rate sensitivity) is 6.5 years, compared with a category average of 5.8. And nearly 40% of its holdings are bonds rated below single-B, compared with 9% for its typical rival. Because the fund invests only in dollar-based bonds, it didn’t suffer as much as funds that held bonds denominated in foreign currencies when the buck surged in 2014 and early 2015.
But don’t underestimate the risk. Over the past three years, the Vanguard fund was more than twice as volatile as the main U.S. bond index. Rising interest rates and growing fears about the health of emerging nations could torpedo results. And if the dollar weakens, the fund, which yields 4.1%, could turn into a laggard.
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