Vanguard Short-Term Bond Holds Up Well When Credit Spreads Widen

Vanguard Short-Term Bond BSV Index’s broad reach, market-value weighting approach, and rock-bottom fees make it a strong choice for U.S. short-term bond exposure.

The Bloomberg U.S. 1-5 Year Government/Credit Index, which underpins this fund, takes a simple but sensible approach. The benchmark sweeps in Treasuries, government-related bonds, and investment-grade corporate debt with between one and five years until maturity. It weights bonds by their market value, which channels the market’s consensus opinion of each bond’s relative value. The U.S. short-term bond market is reasonably efficient, making it hard to outsmart the collective market. Market-value weighting favors the issuers that borrow the most, but this fund focuses on investment-grade borrowers who have the resources to service their debt. The drawback is that bond-issuing activity influences the portfolio’s composition.

Government bonds dominate this portfolio. U.S. Treasuries constituted about 72% of the portfolio at the end of June 2023, despite a float adjustment designed to curtail Treasury exposure. The fund invests most of its remaining assets in corporate debt, representing 27% of the portfolio at the end of June—an allocation 19 percentage points leaner than the average of fellow short-term bond strategies. The fund excludes securitized debt, which constituted over 27% of its average peers at the end of June 2023. This lopsided sector exposure breeds a conservative portfolio that is much less sensitive to credit risk than most.

The fund can entertain more interest-rate risk than its peers, though. Its 2.7-year average effective duration exceeded its standard peer’s 2.3 years as of June 30, 2023. So, this fund should hold up well when credit spreads widen but may languish in rising-rate environments, like when it trailed the category average by over 5 percentage points in 2022.