Vanguard Short-Term Investment-Grade Keeps It Short and Sweet

Rising interest rates have squelched returns in the broad bond market—when interest rates rise, bond prices fall. But Vanguard Short-Term Investment-Grade (symbol VFSTX) focuses on debt with one- to five-year maturities, which makes it less sensitive to interest-rate shifts. That’s partly why the fund’s 4.2% return over the past 12 months beat the Bloomberg Barclays U.S. Aggregate Bond index. Short-Term Investment-Grade, a member of the Kiplinger 25, beat its bogey, the Bloomberg Barclays U.S. Government/Credit 1-5 Year index, over the past year, too.

Nimble moves by lead manager Arvind Narayanan also helped. Heading into 2020, Narayanan, who runs the fund with Daniel Shaykevich and Samuel Martinez, shed some corporate bond holdings—he viewed them as “rich,” he says—and scooped up less-risky mortgage-backed securities instead. That conservative positioning paid off in the spring of 2020 as bond prices sold off amid COVID fears. Corporate bonds suffered more than mortgage debt did, and that created opportunity. The managers then “recycled back,” as Narayanan says, into high-quality corporate debt, just as a rally in those securities began last summer.

Narayanan and his team are positioning the fund now for a strong economy and the potential for higher inflation and rising interest rates. The fund still holds corporate debt, but now that bet is more focused on low-quality investment-grade debt (rated triple-B) and high-quality high-yield debt (rated double-B). They also like consumer-oriented asset-backed securities, such as auto loans. To compensate for the extra risk, the fund holds more cash and short-term Treasuries—12% of the fund’s assets—than usual. It also means the managers can be “opportunistic” if the option arises, he adds.

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Narayanan is still relatively new to the fund, but he has 20 years of experience in the bond market. And he’s got his eye on the ball. “The fund’s use case … is to provide a reliable source of income with some price appreciation and to help protect investors from large drawdowns,” he says. Since he joined in late 2019, the fund has gained 3.8% annualized, which beats its peers (short-term bond funds). The fund yields 0.85%.