Why Vanguard Short-Term Bond Index Stands Out

Key Morningstar Metrics for Vanguard Short-Term Bond Index

• Morningstar Medalist Rating: Silver
• Process Pillar: Above Average
• People Pillar: Above Average
• Parent Pillar: High

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

The Bloomberg US 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 US 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 that have the resources to service their debt. The drawback is that bond-issuing activity influences the composition of the portfolio.

Government bonds dominate this portfolio. US Treasuries constituted about 73% of the portfolio at the end of August 2024, despite a float adjustment designed to curtail Treasury exposure. The fund invests almost all of its remaining assets in corporate debt. Still, its corporate allocation was about 12 percentage points leaner than the average of fellow short-term bond strategies. The fund excludes securitized debt, which constituted over 29% of its average peer at the end of August 2024. 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 average effective duration was actually just shy of its average peer’s 2.7 years as of August 2024 but has historically been longer. 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.

Vanguard Short-Term Bond Index: Performance Highlights

This fund has measured up well against its short-term bond peers. Over the two decades through August 2024, the exchange-traded fund led the category average by 33 basis points per year with comparable volatility. The fund should stack up best when credit spreads widen, but its paper-thin fee aids performance no matter the environment.

This Treasury-laden fund should beat its corporate-debt-heavy peers when credit spreads stretch. It fared well when the global financial crisis rollicked markets, for example. Its 5.48% return in 2008 comfortably ranked within the short-term bond peer group’s top decile. It tends to trail the pack when credit risk pays off, though. The Admiral share class lagged its average peer by 1.44 percentage points in the second half of 2020 as markets rebounded from the pandemic-fueled drawdown.

Inflationary environments challenge the fund because of its longer-than-average duration. It slid 29 basis points further than the category norm in 2022 against the backdrop of rising interest rates. The deficit likely would have been steeper had credit spreads not widened at the same time.

This fund’s most durable advantage lies in its best-in-class fee. Each share class charges only a few basis points per year, presenting a smaller hurdle than nearly all category peers.