Vanguard hedged global bond vs. VAGS

aroominyork

These two funds have tracked each other over the last three years (soon after the ETF was launched) - barely a ciggie paper between them. The OEIC has about 50% more holdings, something like 15,000 to 10,000. Presumably the extra 5000 do not add any material difference or diversification, so at what point does a fund say enough is enough?

masonic

aroominyork said:

These two funds have tracked each other over the last three years (soon after the ETF was launched) - barely a ciggie paper between them. The OEIC has about 50% more holdings, something like 15,000 to 10,000. Presumably the extra 5000 do not add any material difference or diversification, so at what point does a fund say enough is enough?

You'll see this is in common with Vanguards equity OEICs vs ETFs. As the funds are cap-weighted, the extra proportion of the market that is captured by having double or triple the number of holdings will be quite small. ETFs may use optimised sampling to select a representative cross-section of companies rather than fully replicate an index, or choose an index that is less broad in scope. This reduces costs and can therefore lead to a better outcome for investors if done properly.

Many are happy with using the S&P500 and capturing 80% of the US market vs the Russell 3000 which covers 97%, and it has done them no harm as performance of US mid and small caps has generally been disappointing. However, past performance is no guide to the future. For bonds, missing out on the smallest issues would be of even less consequence, since all you really need is the right spread of credit rating and sufficient diversification to mitigate default risk. There will be no bonds making unexpected exceptional returns.

aroominyork

Thanks so much, masonic. Is it a requirement across all investment companies, rather than being a Vanguard-specific choice, that OEICs have to replicate the full universe while ETFs can be more selective?

MK62

Both fund and ETF track the same index now, but that index was only created in 2019......the fund was launched in 2009, while the ETF was launched in 2020......ergo the fund tracked a different index at least pre 2019. The currently used index is really a subset of another older index, but using less CNY denominated bonds. 
You may find the fund might be steadily reducing the number of holdings in view of this.....but only Vanguard will know that for sure.

masonic

There is no requirement for OEICs to track broader indices than ETFs. There are OEICs tracking narrow indices, the HSBC FTSE 100 Index fund and HSBC American Index fund (tracking S&P 500) have been around since the late 1980s. In recent times there has been a lot of competition between fund houses to drive down charges and provide to lowest cost options for investors. Diversification into the smallest constituents of the investable market does not seem to be a priority for their customers, with the narrower scoped funds enjoying success, so more of those funds are being launched in order to keep costs and charges down. It happens that many new launches have been in the ETF space.

aroominyork

MK62 said:

Both fund and ETF track the same index now, but that index was only created in 2019......the fund was launched in 2009, while the ETF was launched in 2020......ergo the fund tracked a different index at least pre 2019. The currently used index is really a subset of another older index, but using less CNY denominated bonds. 
You may find the fund might be steadily reducing the number of holdings in view of this.....but only Vanguard will know that for sure.

Some global aggregate bond index funds include Chinese govt bonds - typically about 8% of the total - while others exclude them. If buying bonds as a diversifier does this difference figure in people's decisions?

Linton

aroominyork said:

MK62 said:

Both fund and ETF track the same index now, but that index was only created in 2019......the fund was launched in 2009, while the ETF was launched in 2020......ergo the fund tracked a different index at least pre 2019. The currently used index is really a subset of another older index, but using less CNY denominated bonds. 
You may find the fund might be steadily reducing the number of holdings in view of this.....but only Vanguard will know that for sure.

Some global aggregate bond funds include Chinese govt bonds - typically about 8% of the total - while others exclude them. If buying bonds as a diversifier does difference this figure in people's decisions?

Diversification in equity is important because the individual underlying investments are subject to high specific risk eg a fair number of individual companies will go bust. Some sectors may collapse, others will thrive.  But you cannot predict which.    Safe government bonds do not suffer that degree of risk as all are largely driven by global interest rates, that is one of the main reasons for investing in such bonds in the first place.

So I see little point in worrying about geographic diversification in governmant bonds.  More important is whether the characteristic of your chosen bonds are appropriate for your needs.  If you are investing in fixed interest for income having a range of different types of investment eg government bonds, corporate bonds, infrastructure etc is important.  In some of these there is more specific risk and so diversification across sector and geography may be important.

masonic

My view is that UK gilts have a sufficiently low risk of default. Index linked gilts are available to hedge against inflation risk. Duration risk is a problem for vanilla gilt trackers, but one can manage duration by self-selecting individual gilts or buying a combination of vanilla and short dated funds.

It's a different story for corporate bonds. If there's an argument to include these in a portfolio at all, then why restrict yourself to companies that happen to be listed in one market?

If you have a need to use an aggregate fund rather than separate funds for govt vs corp, then a compromise must be made.