Rates are hard to predict, but a good rate strategy can still add value

November 13, 2019

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Anne Mathias

Anne Mathias

John Hollyer

John Hollyer

A little more than a year ago, central banks around the world were either actively raising rates or talking about doing so in the near future. But, by year-end, the opposite began to happen. The U.S. Federal Reserve stopped raising rates, and the European Central Bank (ECB) backed away from any rate increases in the near term. More recently, both the Fed and the ECB have actively eased monetary policy.

Developed-market central banks now have interest rates at relatively low levels—even outright negative levels in Europe. Central banks alone have a limited tool kit, and with low (and even negative) interest rates, their room to maneuver shrinks. As a result, fiscal policy will become increasingly important to managing the economies of these countries, especially in the event of a recession.

It's an environment that highlights the need for a long-term investment strategy when it comes to rates. Because only by having a long-term horizon can you avoid being caught up in the reactive hunt for yield many investors now find themselves in—a hunt that all too often results in investors shooting themselves in the foot.

Farmers, not hunters

Leveraging Vanguard's global rates team, our actively managed fixed income funds utilize rates strategies that are more strategic than reactive.

"We're not forced by low nominal absolute rates to go hunting for yield," said Anne Mathias, global rates and foreign exchange (FX) strategist at Vanguard. "We might discern that there could be a theme that would create strategies around relative value, but we're more like farmers than hunters. We've got our field and tend to it with tools and strategies designed to maximize the harvest, no matter the market environment."

That it's a big, global field is by design. Having experienced rates experts and global mandates gives Vanguard the ability to look for relative value between different sovereign yields. For example, German, Spanish, and French government bonds are viewed as part of the same opportunity set as U.S. Treasuries.

In fact, in the second and third quarters of 2019, the rates team was able to create a successful strategy (led by our European rates portfolio manager, John Madziyire) around what they believed would be a narrowing of the spread between German and Spanish bonds, Ms. Mathias said.

"We felt there was a better risk/reward opportunity for that difference between those two bond yields to get smaller than there was for the U.S. Treasury yield to fall," she said. "So, we allocated resources to that relative value strategy in Europe, and it was very beneficial to our actively managed bond funds."

A team approach

Importantly, it's the fund's portfolio manager who allocates the resources after the rates team identifies a potential opportunity. This highlights the collaborative nature in which different teams work to try to achieve the best possible outcome for investors.

A specialized, collaborative framework

A specialized, collaborative framework

The global rates team is composed of groups responsible for looking for opportunities with Treasuries and Treasury Inflation-Protected Securities (TIPS); non-U.S. rates; and mortgage-backed securities (MBS), agency debt, and volatility strategies.

As the global rates team continues to evolve, it is developing and building upon existing capabilities: For example, the relationship between major developed-country currencies is very closely tied to movements in relative interest rates and monetary policies in each country. The team, led by Ms. Mathias and Andy Maack, our head of FX trading, has become more involved in the FX space by looking for opportunities in how currencies move relative to each other and developing strategies around such opportunities. The team also continues to build out its quantitative analytical capabilities and MBS resources.

The rates team complements the credit team, which is also composed of several distinct groups that conduct thorough macro- and micro-level analyses to form independent views on the credits in which Vanguard invests.

"In constructing portfolios, the rates and credit teams collaborate and engage in healthy debate about the expected interaction of rates and credit and the benefits of coordinating the two sides," said John Hollyer, global head of Vanguard Fixed Income Group. "In many environments, rates and credit strategies diversify one another, and blending them thoughtfully can improve the risk/reward of a portfolio."

A question of breadth

One could argue the rates team has the tougher assignment. There's much greater breadth in the world of corporate credit—more selection opportunities. In response, the rates team has pursued a long-term initiative to add breadth by developing capabilities across the TIPS, MBS, FX, and other markets, including rates markets outside the U.S.

"We have senior people in the U.S., London, and the Asia/Pacific region," Ms. Mathias said. "We also have a process that allows us to think about opportunities, regardless of geography."

But it also helps that the rates team works closely with the Vanguard Investment Strategy Group (ISG), which focuses on economic research.

"They are looking at the major macro factors that drive central bank decision-making," Ms. Mathias said. "Understanding how our economists think about those macro factors—that's incredibly important to the work we do."

Informed by ISG's thinking and armed with a global perspective, the rates team can hone its view of where rates may be heading. This, in turn, can help Vanguard's active fixed income managers make better decisions.

"The importance of having a long-term global rates strategy can't be overlooked, especially when markets throw you a curve ball," Mr. Hollyer said. "You may not hit a home run all the time, but you can enhance your risk-adjusted return and improve your batting average."


  • All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Past performance is no guarantee of future returns.
  • Bonds are subject to the risk that an issuer will fail to make payments on time and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments. While U.S. Treasury or government agency securities provide substantial protection against credit risk, they do not protect investors against price changes due to changing interest rates.