Vanguard Group reminds RIAs not to overplay near-zero-risk, high-return cash game and also releases new fund products to transition back to bonds

Never play the game too long because you can get caught short.

Vanguard Group is warning RIAs the Federal Reserve may be shifting the odds away from the zero-risk, high-return cash game.

At the same time, it's rolling out more cash-like ETFs as a carrot to lure investors back to bonds, which may carry higher fees and higher risks of capital losses – but also represent a way to lock in high rates before they dissipate.

The Malvern, Pa. manager of $10 trillion told advisors in a mid-November note “now” is the right time to consider locking in future returns, citing another likely Federal Reserve (Fed) rate cut. 

It also just launched four bond funds – two of which are already available to buy and a further two that will formally launch early next year. The investments are designed to "fill the gap" between money market funds, ultra-short-term bonds, and cash. See: Vanguard reads the room.

"If you have a long enough time horizon to get into the fixed-income market now … you're more likely than not to outperform cash," says Dan Newhall, Vanguard principal and head of portfolio solutions, in FA-Mag.

The Fed cut interest rates by 50 basis points in September, and by a further 25 basis points in early November. The fed funds rate now sits in the range of 4.50% to 4.75%.

Protect yourself

Central bankers today (Dec. 3) said they continue to believe inflation is heading down to their 2% target and signaled support for further interest rate cuts ahead. None pushed strongly for or against a cut when they next meet to set rates in two weeks, according to Reuters. 

“Advisors and their end-clients should be reconsidering the outlook for cash and whether there’s reinvestment risk,” says Newhall.

Vanguard is certainly eager to capitalize on its market prognoses, largely by making sure it has enough product depth.

In the last three months alone, Vanguard has rolled out two new active municipal bond funds, and two short-duration active Treasury bonds. 

A recent Vanguard study also cautions that if advisors dally too long in cash, the portfolios they manage will likely suffer.

In 16 of the last 17 cycles of rate cuts, fixed-income outperformed cash, and in six of the last seven rate-cutting cycles, it did so by between 10% and 30%, the study reports.

Signal to Advisors

Yet, its analysis must be taken “with a grain of salt,” says Jeffrey DeMaso via email, a long-standing analyst of the firm, and co-founder and editor of the Independent Vanguard Advisor.

“This [call] is a little bold of Vanguard, but also not out of the norm, or the new normal. [Roger] Aliaga Diaz told Barron's in July that the Fed wouldn't cut rates this year; that was not a good forecast,” DeMaso observes.

Aliaga-Diaz is Vanguard's chief economist, Americas and global head of portfolio construction.

Indeed, Vanguard cautions that its note to RIAs is not “a tactical call on the markets, but instead, a signal for advisors to analyze their clients’ strategic asset allocation, and understand the role of cash in their portfolio,” a spokesperson explains.

Vanguard is protecting itself with its cash call, too, because if rates fall, the cost of running its money market funds will hit its bottom line, says DeMaso.

“The clear advantage [fixed-income funds] have from Vanguard's seat is if the Fed goes back to zero-interest rates.

"In the past, when that has happened, Vanguard has had to waive fees on its money market funds to keep the after-fee yield above 0%."

Time bomb

In one clear implication, Vanguard appears to be bracing for a potentially significant recession – or stagflation – once the Trump administration takes office, which could lead to a rapid shift in interest rates. 

The 2020 pandemic lockdown triggered a deep economic downturn and sparked a “dash for cash." To prop up the economy, the Fed cut its target federal funds rate by 1.5 percentage points in a matter of three weeks, dropping the funds rate to a range of 0% to 0.25%.

Trump promised during the 2024 presidential campaign to impose hefty tariffs, cut taxes by almost $10 trillion over 10 years, deport millions of immigrants, and fire thousands of federal workers across the country. 

“Given the massive size of the federal deficit, that’s going to blast a huge hole in the national budget. He’s sitting on a time bomb,” said James J. Angel, an associate professor at Georgetown University’s McDonough School of Business.

“Depending on how you think the Fed might react to the rise in import prices, you could see rising interest rates… so you could see something like stagflation,” said Marcus Noland, executive vice president and director of studies at the Peterson Institute for International Economics. 

“It’s not a very pleasant scenario to contemplate."

 The Vanguard “mindset”

Vanguard's call to lock-in rates also follows a multi-year fixed-income rejig at the firm, a process that has included multiple hires over the last four years, a slew of new fund launches, and a bigger push into actively managed bond funds. See: Vanguard re-applies itself to active fixed-income.

Two months after new CEO, Salim Ramji took the Vanguard reins, he gave the initiative his blessing, stating that Vanguard will disrupt fixed-income markets with “the same mindset” it applies to equities markets. See: Salim Ramji takes Vanguard CEO helm.

“The opportunity set is vast when you look at the fixed-income market. It’s twice the size of the equity market and the inefficiencies in fixed income are extraordinary," he told the Financial Times (FT), in late September.

"The fixed income market today … it’s far more antiquated, it’s far less transparent, far more expensive ... there’s an opportunity that Vanguard has to change that.

“[It's also] going to be more important in … the long-term rate environment,” he added.

Bonds are “riper for the picking” and so Vanguard is “doubling down," Morningstar senior analyst, Daniel Sotiroff told the FT earlier this year. 

New fund magic

Since Vanguard began restructuring its fixed-income unit in 2020, it has regularly launched new fixed-income products. See: Into the PIMCO void, Vanguard re-applies itself to active fixed-income funds.

“Fixed income has always been an important part of our broader portfolio ... offering our investors quality … at a very low cost,” says a company spokesperson, via email.

“We’ve launched products like our Core and Core-Plus Bond ETFs [December 2023], along with our latest municipal ETFs [Nov. 21], to demonstrate our commitment." See: Vanguard's shuttering of municipal money market funds sends clarion call.

Vanguard also just announced its Ultra-Short Treasury ETF and its 0-3 Month Treasury Bill ETF, Nov. 24. 

They will launch next year, according to a release. 

The new funds “fill the gap between Vanguard’s money market funds and our existing ultra-short-term bond offerings,” says Vanguard global head of portfolio review, Daniel Reyes, in the release. See: A 'late' Vanguard Group joins crowd selling ultra-short bond ETF --managed by humans.

“We take a very thoughtful and enduring approach to product development, ensuring that anything we launch has lasting investment merit, fulfills the long-term needs of our clients, and can stand out in the marketplace,” adds the company's spokesperson.

Hard data

In full, Vanguard manages 77 fixed-income funds – and six money market funds – 88% of which focus on US markets, split between investment-grade funds, municipal bond funds, treasury funds, and junk-bond funds. Around 28% are short-duration, 48% intermediate, and 23% long, according to its website.

Of the $1.7 trillion of fixed-income assets under its management (AUM) – 17% of its overall total – it manages around $782 billion actively, and a further $918 billion passively, according to public data. 

Money market funds held $6.927 trillion as of Oct. 31, according to the latest SEC money market fund report. 

Money market fund assets have just topped $7 trillion, according to a Nov. 21 Reuters report.