Vanguard’s £9.6bn Lifestrategy range is exposing investors to interest rate risk, as governments and corporates buying up cheap, long-dated debt skew duration in indices that the passives giant tracks.
Duration varies between 9.1 and 9.2 years in the four products in the Lifestrategy range that allocate to fixed income, according to Morningstar. The funds use fixed rather than active asset allocation meaning their high interest rate sensitivity is a strategic rather than a tactical call.
Actively-managed multi-asset rivals of Lifestrategy have duration of less than two years.
Vanguard Lifestrategy 60% Equity holds the largest amount of assets with £3.7bn drawn to the traditional equities to bonds asset allocation. Lifestrategy 20% Equity, the fund with the largest exposure exposure to bonds, holds £774.7m. All funds in the range have an ongoing charges figure of 0.22%.
Morningstar analyst Randal Goldsmith says, all else remaining equal, the range would underperform in a rising interest rate environment.
Performance in Vanguard Lifestrategy range
| 3m | 6m | 1yr | 3yr | 5yr | |
| Vanguard LifeStrategy 20% Equity | -1.71 | -0.75 | 0.92 | 10.15 | 22.17 |
| Vanguard LifeStrategy 40% Equity | -2.55 | -0.99 | 2.40 | 15.30 | 33.28 |
| Vanguard LifeStrategy 60% Equity | -3.30 | -1.07 | 4.12 | 20.60 | 44.97 |
| Vanguard LifeStrategy 80% Equity | -4.12 | -1.23 | 5.79 | 25.82 | 57.12 |
| Vanguard LifeStrategy 100% Equity | -4.97 | -1.43 | 7.44 | 31.13 | 70.01 |
Source: FE Analytics
Since the fettered fund of funds range launched in June 2011, bonds have outperformed alternative assets used by rival multi-asset managers, Goldsmith notes. “That helps the relative performance of the Vanguard range,” he says.
The funds invest exclusively in bonds and equities through Vanguard’s index range.
In Lifestrategy 20% Equity, for example, the top three holdings are: Vanguard’s Global Bond Index, FTSE Developed World ex-UK Equity Index and UK Government Bond Index funds.
A Vanguard spokesperson said the fixed income asset allocations within Lifestrategy 20, 40, 60 and 80 include government securities, which are often longer duration, and corporate bonds.
“These allocations are static and are maintained over the long term. The Lifestrategy funds do not look to time the market through tactically allocating, either in regard to asset classes or individual securities,” the spokesperson said.
GOVERNMENT DEBT UPS DURATION
Governments taking advantage of low interest rates to issue long-dated debt is driving up duration in bond indices, says AJ Bell head of fund selection Ryan Hughes.
Duration on the Bloomberg Barclays Sterling Gilt Float Adjusted Index is currently 12.4 years. Hughes says that figure was around seven years a decade ago.
“Governments and corporates have been issuing longer and longer dated debt to take advantage of low rates. There is more interest rate risk in the benchmark today than there has been in my entire investment career,” Hughes says.
The Lifestrategy fixed income allocation is market weighted with a home bias tilt towards the UK, meaning it holds a relatively high gilts exposure.
AJ Bell is currently using passive ETFs with 0-5yrs duration for its gilts exposure in its managed portfolio service.
Fidelity Moneybuilder Income and TwentyFour Corporate Bond both feature in the active MPS range and have duration of 7 years and 6.5 years compared to 8.2 years in the Bank of America Merrill Lynch Euro-Sterling Index.
Active MPS 1, the lowest risk portfolio in the AJ Bell range and therefore the one with the highest bond allocation, has duration of five years.
NORMALISATION
The US Federal Reserve is currently expected to deliver four hikes in 2018, while the Bank of England is forecast to deliver two this year.
Hughes says that is likely already factored into pricing.
However, he adds: “If there are any surprises where rates need to rise faster than the markets, then that could have a significant impact on those investors who are positioned at the longer end of the duration curve,” he says.
Portfolio Adviser spoke to several other multi-asset managers with even lower duration than AJ Bell.
Old Mutual Wealth assistant portfolio manager Sacha Chorley says duration is “just shy of two years” in their medium risk portfolios. Chorley says they are looking to credit as opposed to taking interest rate risk in government bond markets.
At Miton Asset Management, duration ranges from 1.9 in the Cautious Monthly Income fund to 5.9 years in the Balanced fund. In 2014, duration got has high as 15 years in the multi-asset range, managed by David Jane and Anthony Rayner.
LOGIC TO FIXED ALLOCATION
However, Goldsmith says mixing government bonds and equities in a “set and forget” portfolio is logical.
He says: “The most reliable diversifier for equity risk among assets that go well in a mutual fund is basically government bonds.
“From the point of view of Vanguard, they’re not trying to time the market, they’re not trying to do tactical asset allocation, they’re trying to put together something you could sit with forever.”
Vanguard’s spokesperson said the range applies a number of best practises, including top-down strategic asset allocation, broad diversification and a balance between risk, return and cost.
