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:

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Portfolio 1 VWOB, Portfolio 2 VEGBX
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Holdings VEGBX
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Holdings VWOB
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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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jhfenton
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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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jhfenton
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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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