© Reuters. FILE PHOTO: The logo for Vanguard is displayed on a screen on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., June 1, 2022. REUTERS/Brendan McDermid
By Davide Barbuscia
NEW YORK (Reuters) – Vanguard, the world’s second-largest asset manager, increased exposure to large bank’s bonds during the banking rout in March, taking advantage of cheap valuations, according to a report seen by Reuters.
The collapse of two U.S. regional banks last month triggered wild price fluctuations across fixed income markets, with worries over the banking sector weighing broadly on corporate bond prices.
“The banking troubles offered a brief window to add large banks at compelling valuations,” said the report, written by Sara Devereux, global head of fixed income group, and her team.
“We had little exposure to troubled banks and do not see evidence of a systemic risk to the financial system,” it said.
Vanguard expects volatility in bond markets to continue in coming months, which could present more opportunities to buy oversold debt securities, but it remains cautious about adding risk to its bond portfolios as it expects the economy to enter a recession this year.
“The time for a full risk-on moment has not yet arrived,” the report said.
Last month’s bank failures have strengthened expectations of a slowdown in the economy, as banks are expected to become more cautious and restrict lending.
Investors are now assessing whether the Federal Reserve will keep hiking rates to fight inflation after a largely expected 25 basis point hike at its next rate-setting meeting in May. Many expect the central bank to cut rates later this year to loosen the grip of higher borrowing costs on the economy.
Core inflation, however, is likely to be sticky, according to Vanguard, limiting the Fed’s ability to ease monetary policy in coming quarters.
“We believe the Fed will ultimately hoist the fed funds rate above 5% by mid-year before pausing,” it said.
“Barring a major economic surprise, we think the Fed will hold policy rates high for longer than the market currently expects.”
Vanguard, the world’s largest asset manager, made the most of the financial panic in March by being one of the few investors to buy high-quality bonds from large banks at a discount.
The market turmoil brought on by the novel coronavirus pandemic caused a “dash for cash” in the bond markets as investors looked to move their capital into safer investments. Banks, which have relied on the bond markets to raise funds, saw their borrowing costs spike, forcing them to pay more to debt investors.
In a rare move, Vanguard took advantage of the confusion in the market by purchasing bonds issued by large banks at a discount. This enabled the company to buy high-quality securities at lower prices than usual and in larger quantities than usual.
The discounted bonds were part of the asset manager’s “total return” strategy, which seeks to maximize return over the long term. This enabled Vanguard to increase its market presence and also to reduce its holding costs, as it was able to buy the bonds for less.
The bond purchases were a shrewd move for Vanguard and could potentially pay off in the long run. By buying high-quality securities from large banks at a discount, the asset manager has created an opportunity to make money from the market chaos. It remains to be seen whether or not the move will pay off, but Vanguard’s decision shows that the company is willing to try new strategies in order to maximize its returns.