Vanguard Bond Chief Says Losses Aren’t Locked in When Fed Tapers

A reduction of quantitative easing by the Federal Reserve needn’t be a harbinger for losses with growth slow and inflation subdued, according to Gregory Davis, named last week as head of fixed income at Vanguard Group Inc.

“You can have some tapering of QE, but at the end of the day, you still have an economy that’s relatively weak, that’s showing a few signs of life,” Davis, 43, said in a Nov. 7 telephone interview from Sydney, where he serves as chief investment officer for the Asia Pacific region and a director of the mutual-fund company’s Australia unit. “Inflation is still low, the labor market is relatively fragile, the expectations are the Fed’s going to remain accommodative for a long period of time.”

The U.S. central bank is forecast to begin tapering its bond purchases in March, according to Bloomberg surveys of economists on Nov. 8, while interest-rate swaps data show the first benchmark rate increase will take place in May 2015. The Fed may adjust its forward guidance on the timing for any policy interest-rate increase and how it is linked to economic performance measures, such as the nation’s jobless rate, said Davis, who will oversee $750 billion when he takes over in March at Valley Forge, Pennsylvania-based Vanguard, the world’s largest mutual fund company.

Bond Holders

Investors planning to hold bonds for the long-term needn’t be concerned about losses when yields are rising, said Davis, who graduated from Pennsylvania State University and the University of Pennsylvania’s Wharton School of Business.

‘If rates rise, and you’re in an intermediate-term bond fund, rates rising isn’t a bad thing in the long term because you’re going to be reinvesting those coupons and principal payments over time at higher rates,’’ he said.

Davis will succeed Robert Auwaerter, 58, who will retire in March after leading the fixed-income group since 2003. Vanguard, with total assets under management of $2.4 trillion as of Oct. 31, is the second-largest holder of U.S. Treasuries with $166.3 billion, according to data compiled by Bloomberg. Pacific Investment Management Co. holds $167.1 billion of the debt, the data shows.

The Fed’s decision to cut back on bond buying will depend on its perception that economic activity is picking up in a sustainable manner, said Davis, who spent nine months at Merrill Lynch & Co. before moving to Vanguard as a trader on its bond-index desk in 1999.

Fed Speculation

Vanguard projects the Fed’s decision to taper bond purchases is likely in the first three months of 2014, Davis said. Policy makers began their third round of asset purchases in September 2012 with $40 billion a month of mortgage securities and extended their efforts with $45 billion a month in Treasuries beginning January.

Sluggish growth and a Fed prepared to focus policy guidance on achieving a lower unemployment rate of about 5.5 percent to 6 percent suggest that the intermediate part of the yield curve will benefit, Davis said.

“There are other ways the Fed can continue to anchor the market and will, to some degree, anchor where the very short end of the curve is,” Davis said. “And depending on how long that anchoring lasts it’s going to have an impact on the intermediate part of the curve as well.”

Market Returns

The five-year U.S. Treasury note returned an average 1.9 percent in each year from 2003 through 2006, even as the yield rose to 4.69 percent from 2.73 percent during the period, Bank of America Merrill Lynch five-Year U.S. Treasury Index shows. The securities gained an average 7.1 percent in the next four years through 2010 as the yield fell to 0.83 percent.

Corporate bonds are likely to maintain their superior performance relative to Treasuries in the coming year, Davis said. U.S. government debt has declined 2.7 percent this year while high-quality company obligations have lost 2.2 percent, Bloomberg bond indexes show.

Vanguard’s $109 billion Total Bond Market Index Fund, including $17 billion in Exchange Traded Fund shares, its largest fixed-income offering, has lost 2 percent this year, trailing 73 percent of its peers.

Davis said he work as head of Vanguard’s bond-indexing group will help him in the expanded role, along with his time working for Auwaerter.

“He’s a brilliant man and I’ve learned a great deal from him about how to look at markets and valuations and think about risk,” Davis said.

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