Emerging Bonds: Index (VWOB) vs Active (VEGBX )

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hdas
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Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by hdas » Tue Jun 11, 2019 1:13 pm

14% of my Beta retirement portfolio is in Emerging Fixed Income (Hedged), using VWOB. I have no complains. However, the active Vanguard offering VEGBX is very intriguing. As a principle I prefer the index but I'm trying to figure out if there's a good case for going active here, let's look at the main differences:

Image

Portfolio 1 VWOB, Portfolio 2 VEGBX
Image

Holdings VEGBX
Image

Image

Holdings VWOB
Image

Image

Notes:

>>> Short window of time to make conclusive judgement about performance
>>> Quality of holdings
>>> Vanguard offers:
investors are advised to examine the case for adding non-market-cap-weighted emerging-market fixed income to their portfolio
Does anybody have a sophisticated opinion? Thx :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by jhfenton » Tue Jun 11, 2019 2:18 pm

hdas wrote:
Tue Jun 11, 2019 1:13 pm
Does anybody have a sophisticated opinion? Thx :greedy
I don't know that my opinion is sophisticated, but I opted for VEGBX. I invested a little bit in the Investor shares on launch day (12/6/17) and then bumped it to a hair over $50K the following week and converted to VEGBX. (My $50,0xx has grown to $55,7xx with no additional money and reinvestment of dividends. I plan to keep it at 5%, and it has stubbornly stayed just above that threshold this year.)

In my opinion, there is nothing magical about market-cap-weighted indexing. The primary reason MCW indexing outperforms is cost. Also, in very liquid equity markets, it generally offers the lowest implementation costs. It is also a reasonable approach for treasury and similarly-liquid "risk-free" bond markets.

I am less enamored of MCW indexing in credit markets. Credit markets are less liquid (perhaps less efficient?). Transaction costs are higher. A higher market cap means more debt.

That doesn't mean that costs don't matter. An active treasury bond fund might justify 0-1 bp added expense. A high quality corp bond fund a few bp. A high yield fund a few more bp. Most active bond funds underperform (on a credit-risk-adjusted basis) because they don't earn their expenses back, not because they can't eek out a few bp of gross return.

In emerging market debt markets, I see all of those issues as magnified: less liquid, harder to research, etc. So I decided that I was more than happy to pay Vanguard 13 bp (now 15 bp) extra to look for value in emerging market debt. Particularly as long as the fund is relatively small, I thought it seemed likely that Vanguard would be able to earn more than the difference in cost by considering risk and relative value in choosing positions.

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hdas
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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by hdas » Wed Jun 12, 2019 9:04 am

jhfenton wrote:
Tue Jun 11, 2019 2:18 pm
hdas wrote:
Tue Jun 11, 2019 1:13 pm
Does anybody have a sophisticated opinion? Thx :greedy
In emerging market debt markets, I see all of those issues as magnified: less liquid, harder to research, etc. So I decided that I was more than happy to pay Vanguard 13 bp (now 15 bp) extra to look for value in emerging market debt. Particularly as long as the fund is relatively small, I thought it seemed likely that Vanguard would be able to earn more than the difference in cost by considering risk and relative value in choosing positions.
The difference in performance is so dramatic that there most be more to the story, however, I don't see a big difference in the quality of the holdings. Maybe this is true alpha!!. :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by jhfenton » Wed Jun 12, 2019 9:43 am

hdas wrote:
Wed Jun 12, 2019 9:04 am
jhfenton wrote:
Tue Jun 11, 2019 2:18 pm
hdas wrote:
Tue Jun 11, 2019 1:13 pm
Does anybody have a sophisticated opinion? Thx :greedy
In emerging market debt markets, I see all of those issues as magnified: less liquid, harder to research, etc. So I decided that I was more than happy to pay Vanguard 13 bp (now 15 bp) extra to look for value in emerging market debt. Particularly as long as the fund is relatively small, I thought it seemed likely that Vanguard would be able to earn more than the difference in cost by considering risk and relative value in choosing positions.
The difference in performance is so dramatic that there most be more to the story, however, I don't see a big difference in the quality of the holdings. Maybe this is true alpha!!. :greedy
This is probably an area in which there is still some alpha to be found with some--15 bp worth of--hard work. There are no standardized financial reports to rely on. There are hard to quantify political risks. There are liquidity issues to navigate.

And it's not as if there is a single global bond market. Perhaps internal availability of capital leads to divergence in relative values between countries? An index cannot avoid the expensive countries, an active manager can.

I don't have the data to quantify anything. I just knew that I was very interested in the asset class, but was not enamored with the way VWOB was constructed. So I jumped at VEGBX when it became available. I've obviously been happy with my good fortune so far. :beer

(I wouldn't mind a reasonably-priced active or multifactor emerging markets equity fund from Vanguard either. But I don't consider VMMSX at 94 bp to be a viable option. That's just too expensive. At 25 bp I would jump on a multifactor EM fund from Vanguard.)

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by watchnerd » Sat Jan 11, 2020 3:40 pm

hdas wrote:
Tue Jun 11, 2019 1:13 pm
14% of my Beta retirement portfolio is in Emerging Fixed Income (Hedged), using VWOB. I have no complains. However, the active Vanguard offering VEGBX is very intriguing.
Just FYI, VWOB isn't USD-hedged...it's USD denominated. Per the description:

"Because the fund invests only in U.S. dollar-denominated bonds, it does not subject U.S.-based investors to currency risk"
70% Global Market Weight Equities | 15% Long Treasuries 15% short TIPS & cash || RSU + ESPP

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by Razasharpz » Sat Jan 11, 2020 3:59 pm

Always index.

Active is a bad word.
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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by watchnerd » Sat Jan 11, 2020 4:03 pm

Razasharpz wrote:
Sat Jan 11, 2020 3:59 pm
Always index.

Active is a bad word.
Do you think market weight is the way to go with EM bonds?
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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by Razasharpz » Sat Jan 11, 2020 4:14 pm

watchnerd wrote:
Sat Jan 11, 2020 4:03 pm
Razasharpz wrote:
Sat Jan 11, 2020 3:59 pm
Always index.

Active is a bad word.
Do you think market weight is the way to go with EM bonds?
Never owned international bonds in my life and don't think they're necessary in any portfolio.
Age 31: | 70% VTSAX | 20% VTIAX | 10% VBTLX

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by watchnerd » Sat Jan 11, 2020 4:21 pm

Razasharpz wrote:
Sat Jan 11, 2020 4:14 pm
watchnerd wrote:
Sat Jan 11, 2020 4:03 pm
Razasharpz wrote:
Sat Jan 11, 2020 3:59 pm
Always index.

Active is a bad word.
Do you think market weight is the way to go with EM bonds?
Never owned international bonds in my life and don't think they're necessary in any portfolio.
No, EM bonds (not regular international bonds) are not necessary.

But they do play an interesting, non-bond role.

If you take them from the equity side (up to a point), they advance the portfolio efficient frontier.
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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by mjb » Sat Jan 11, 2020 5:55 pm

Indexing works great for highly liquid national bonds and investment grade bonds from developed nation's. Once you get into less liquid, below investment grade, or other specialty risks, active funds do start to out perform. I remember seeing the stats a few years ago where yes, 90% of active stock funds underperform the market after expenses but only 50% of bond funds underperform after expenses.

However, I only have emerging market bonds that are part of short term U.S. bonds, i.e. as part of a basket of Yankee bonds

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by jhfenton » Sat Jan 11, 2020 6:38 pm

Razasharpz wrote:
Sat Jan 11, 2020 3:59 pm
Always index.

Active is a bad word.
Costs matter. Indexing is largely irrelevant except to the extent active management results in higher costs (expenses, taxes, and transaction costs).

I own two active funds--at least where I have a choice in the matter*: VOHIX/Vanguard Ohio Long-Term Tax Exempt and VEGBX/Vanguard EM Bond Admiral Shares. VOHIX is active, but only costs 13 bp. (And there is no index fund equivalent in existence.)

I've owned VEGBX since the day it launched, and it has smoked VWOB. There are a few areas where market cap weighting just doesn't make sense. EM bonds are one of them.

In a defined hyper-efficient market like treasuries, I probably wouldn't pay a single bp for active management. In the US corporate investment-grade space, a manager might squeeze out a few bp of value, but nowhere near 15 bp (holding risk-level consistent). But a little bit of credit analysis and relative value analysis can easily be worth 15 bp in the less efficient, diverse, higher-yielding EM bond space. There is no reason to believe that it is efficient to invest the most in the countries with the most dollar-denominated debt.


* As of yesterday, we own Bond Fund of America in my wife's 401(k). Her plan includes only American Funds funds, so I picked the "cheapest" of a bad lineup.

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by gjlynch17 » Sat Jan 11, 2020 7:06 pm

hdas wrote:
Tue Jun 11, 2019 1:13 pm
14% of my Beta retirement portfolio is in Emerging Fixed Income (Hedged), using VWOB. I have no complains. However, the active Vanguard offering VEGBX is very intriguing. As a principle I prefer the index but I'm trying to figure out if there's a good case for going active here, let's look at the main differences:

Image

Portfolio 1 VWOB, Portfolio 2 VEGBX
Image

Holdings VEGBX
Image

Image

Holdings VWOB
Image

Image

Notes:

>>> Short window of time to make conclusive judgement about performance
>>> Quality of holdings
>>> Vanguard offers:
investors are advised to examine the case for adding non-market-cap-weighted emerging-market fixed income to their portfolio
Does anybody have a sophisticated opinion? Thx :greedy
I certainly do not have a sophisticated opinion but I note that VWOB's weighting to China dropped from 16.8% on April 30 to 1.3% on November 30.

https://investor.vanguard.com/etf/profi ... folio/vwob

This will likely have an impact going forward (not sure whether it is positive or negative) and make historical comparisons less accurate.

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by annu » Sat Jan 11, 2020 7:43 pm

What do you think of getting vegbx in taxable? I do ot have access to this in my 401k. I have vwiux, can maybe add this instead of vtblx or vxus

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by watchnerd » Sat Jan 11, 2020 7:49 pm

annu wrote:
Sat Jan 11, 2020 7:43 pm
What do you think of getting vegbx in taxable? I do ot have access to this in my 401k. I have vwiux, can maybe add this instead of vtblx or vxus
Emerging bonds aren't a substitute for developed bonds like VTBLX.

For better risk adjusted returns, take the allocation from the equity side.

Example: going from 60% equities / 40% total bond => 50% equities / 10% EM bonds / 40% total bonds

These are the types of use cases Vanguard calls out as beneficial in their paper:

https://personal.vanguard.com/pdf/ISGEMB.pdf

Taxable shouldn't be the first choice given the higher yield of EM bonds.
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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by annu » Sat Jan 11, 2020 7:52 pm

Thanks. I see tax efficiency number of less than 2%, does that compare with vxus or vti?

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by watchnerd » Sat Jan 11, 2020 8:03 pm

annu wrote:
Sat Jan 11, 2020 7:52 pm
Thanks. I see tax efficiency number of less than 2%, does that compare with vxus or vti?
Where are you getting this tax efficiency number?

Generally, EM bonds are bond funds, so they're less tax efficient than equity funds.
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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by gjlynch17 » Sat Jan 11, 2020 8:35 pm

watchnerd wrote:
Sat Jan 11, 2020 7:49 pm


Taxable shouldn't be the first choice given the higher yield of EM bonds.
+1. I can't imagine any scenario where it makes sense to put EM bonds in taxable accounts.
watchnerd wrote:
Sat Jan 11, 2020 7:49 pm


For better risk adjusted returns, take the allocation from the equity side.

Example: going from 60% equities / 40% total bond => 50% equities / 10% EM bonds / 40% total bonds
Actually, per the Portfolio Visualizer results linked below, since over the last 12 years a portfolio of 25% US Total Market Index / 25% Total International / 40% US Total Bonds / 10% EM Bonds had better results than a portfolio of 25% US Total Market Index / 30% Total International / 40% US Total Bonds.

The returns were comparable (5.55% vs. 5.50%) but the portfolio with EM bonds had lower volatility (9.04% vs. 9.70%) and a lower maximum drawdown (17.75% vs. 21.58%). I used iShares J.P. Morgan USD Emerging Markets Bond ETF (EBM) for EM bonds as it started in December 2007 and I wanted to include the financial crash in the testing.

https://www.portfoliovisualizer.com/bac ... tion4_2=10

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by watchnerd » Sat Jan 11, 2020 8:53 pm

gjlynch17 wrote:
Sat Jan 11, 2020 8:35 pm


Actually, per the Portfolio Visualizer results linked below, since over the last 12 years a portfolio of 25% US Total Market Index / 25% Total International / 40% US Total Bonds / 10% EM Bonds had better results than a portfolio of 25% US Total Market Index / 30% Total International / 40% US Total Bonds.
[I think you mean 30% Total International above]

Yes, the reduced drawdowns while only giving up a little in returns is the point.

That being said, if you look at the rolling returns, the port with EMB doesn't win every time frame.
Last edited by watchnerd on Sat Jan 11, 2020 9:00 pm, edited 2 times in total.
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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by gjlynch17 » Sat Jan 11, 2020 8:54 pm

watchnerd wrote:
Sat Jan 11, 2020 8:53 pm
gjlynch17 wrote:
Sat Jan 11, 2020 8:35 pm


Actually, per the Portfolio Visualizer results linked below, since over the last 12 years a portfolio of 25% US Total Market Index / 25% Total International / 40% US Total Bonds / 10% EM Bonds had better results than a portfolio of 30% US Total Market Index / 30% Total International / 40% US Total Bonds.
[I think you mean 30% US TSM above]

Yes, the reduced drawdowns while only giving up a little in returns is the point.

That being said, if you look at the rolling returns, the port with EMB doesn't win every time frame.

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by gjlynch17 » Sat Jan 11, 2020 9:02 pm

gjlynch17 wrote:
Sat Jan 11, 2020 8:54 pm
watchnerd wrote:
Sat Jan 11, 2020 8:53 pm
gjlynch17 wrote:
Sat Jan 11, 2020 8:35 pm


Actually, per the Portfolio Visualizer results linked below, since over the last 12 years a portfolio of 25% US Total Market Index / 25% Total International / 40% US Total Bonds / 10% EM Bonds had better results than a portfolio of 30% US Total Market Index / 30% Total International / 40% US Total Bonds.
[I think you mean 30% US TSM above]

Yes, the reduced drawdowns while only giving up a little in returns is the point.

That being said, if you look at the rolling returns, the port with EMB doesn't win every time frame.
Thanks for catching the typo. I fixed it in the post. I concur that the inclusion of EM bonds is not always better. What I found interesting is how close the actual returns of the two portfolios were. I do not currently own any EM bonds as I am still in my accumulation phase (~ five years until hopeful early retirement) and I have not done a lot of research on EM bonds. However, I am intrigued on doing additional research on a retirement portfolio that is lighter on equity but with comparable risk adjusted returns using credit risk (primarily investment grade but including some non-investment grade).

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by watchnerd » Sat Jan 11, 2020 9:09 pm

gjlynch17 wrote:
Sat Jan 11, 2020 9:02 pm


Thanks for catching the typo. I fixed it in the post. I concur that the inclusion of EM bonds is not always better. What I found interesting is how close the actual returns of the two portfolios were. I do not currently own any EM bonds as I am still in my accumulation phase (~ five years until hopeful early retirement) and I have not done a lot of research on EM bonds. However, I am intrigued on doing additional research on a retirement portfolio that is lighter on equity but with comparable risk adjusted returns using credit risk (primarily investment grade but including some non-investment grade).
If you haven't already, you might want to read the Vanguard paper on their role in a portfolio:

https://personal.vanguard.com/pdf/ISGEMB.pdf


Summary:

They're not good for replacing traditional bonds...that actually decreases portfolio efficiency.

They are good for swapping out some large cap or EM equity market risk for a bit of a hybrid risk that is ~50% correlated market correlated, less volatile, and less returns.
70% Global Market Weight Equities | 15% Long Treasuries 15% short TIPS & cash || RSU + ESPP

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by gjlynch17 » Sat Jan 11, 2020 9:13 pm

watchnerd wrote:
Sat Jan 11, 2020 9:09 pm
gjlynch17 wrote:
Sat Jan 11, 2020 9:02 pm


Thanks for catching the typo. I fixed it in the post. I concur that the inclusion of EM bonds is not always better. What I found interesting is how close the actual returns of the two portfolios were. I do not currently own any EM bonds as I am still in my accumulation phase (~ five years until hopeful early retirement) and I have not done a lot of research on EM bonds. However, I am intrigued on doing additional research on a retirement portfolio that is lighter on equity but with comparable risk adjusted returns using credit risk (primarily investment grade but including some non-investment grade).
If you haven't already, you might want to read the Vanguard paper on their role in a portfolio:

https://personal.vanguard.com/pdf/ISGEMB.pdf


Summary:

They're not good for replacing traditional bonds...that actually decreases portfolio efficiency.

They are good for swapping out some large cap or EM equity market risk for a bit of a hybrid risk that is ~50% correlated market correlated, less volatile, and less returns.
Thanks again for the link to the Vanguard paper! I have not read it yet but will add it to my list.

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by jhfenton » Sun Jan 12, 2020 10:34 am

annu wrote:
Sat Jan 11, 2020 7:43 pm
What do you think of getting vegbx in taxable? I do ot have access to this in my 401k. I have vwiux, can maybe add this instead of vtblx or vxus
I agree with the consensus. I wouldn't touch an emerging markets bond fund in taxable. VEGBX is by far the least tax-efficient fund I own. If that were the only space I had for it, I wouldn't own it.

We own VEGBX in my wife's rollover IRA. My 401(k) is catching up, but her IRA is still our largest account. (She had better 401(k) options early in our investing career, when we had to decide which retirement accounts to favor.)

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by annu » Sun Jan 12, 2020 1:49 pm

I asked about taxa ke as will like to invest, buy my 401k is thru fidelity and dont have access to mf, an etf would have been possible.

I will go with the advice and stay away from adding this to taxable.

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Re: Emerging Bonds: Index (VWOB) vs Active (VEGBX )

Post by hdas » Mon Jan 13, 2020 11:30 am

watchnerd wrote:
Sat Jan 11, 2020 3:40 pm
hdas wrote:
Tue Jun 11, 2019 1:13 pm
14% of my Beta retirement portfolio is in Emerging Fixed Income (Hedged), using VWOB. I have no complains. However, the active Vanguard offering VEGBX is very intriguing.
Just FYI, VWOB isn't USD-hedged...it's USD denominated. Per the description:

"Because the fund invests only in U.S. dollar-denominated bonds, it does not subject U.S.-based investors to currency risk"
You are correct. In any case, I did switched from VWOB to VEGBX as soon as I had the flexibility in the Tax Advantage accounts. So far so good. Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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