Tim Buckley: Sarah, you're a key leader in our fixed income group. You head up our rates team and you help set all of our active strategies in fixed income. You've also had decades of experience. We've both been in this business for decades. We've seen turmoil in the bond market before, but this one is a little bit different from other ones we've seen. Usually you'll see dislocation in prices. You're going to see spreads widen, you're going to see it in high yield. Maybe in some investment grade. But this turmoil is echoed almost across all parts of fixed income, so maybe give us a little idea of what are you seeing and what kind of crisis is this and what's behind it?
Sara Devereux: Sure. I think it's predominantly a liquidity crisis. It started in the Treasury market about two weeks ago. We started to see dislocation and off-the-run Treasuries. Now these are securities that typically trade right on top of each other. Very similar yields but we were seeing divergence in pricing. These were early signs that there were liquidity problems.
Tim: That's an odd place to see it first, right? The Treasury market.
Sara: That's right.
Tim: I mean that's supposed to be the best credit out there. Very liquid market. You wouldn't expect to see it there.
Sara: That's right, and it was certainly a warning sign. We noticed it. The Fed noticed it. And they took immediate action. By that weekend, they had announced several measures to address the problem, including quantitative easing and large size. They specifically cited they wanted to address the liquidity in the Treasury and the mortgage market. And then they upsized that QE program and they announced additional facilities to address liquidity in other markets, such as corporate credit, municipals, and even our money markets.
Tim: Because if you look at investment grade the spreads there, in BBBs had widened significantly. They weren't trading very well either, right?
Sara: That's right. This was a problem that was across all asset classes in fixed income, and it was surely a balance sheet problem, some clogs in the system getting liquidity to flow.
Tim: But let's back up a little bit like what's causing this? We've got the COVID-19 crisis. You've got an economic slowdown. You've got a lot of companies, well, they don't know how long they're going to have to last without being able to go get revenue so to speak. So they're going to cash.
Sara: That's right. At times of stress, everybody wants cash. Corporations need it to pay their employees. Banks need it to make loans and there's demand for cash. And typically raising cash is a very smooth exercise in the market. This time was different simply because of the sheer speed of the crisis and the magnitude of the liquidity that was demanded. Frankly, the banking system, the plumbing isn't set up to accommodate this size of flows.
Tim: But if we get liquidity back, you avoid a liquidity crisis becoming a lasting credit crisis. Fair enough?
Sara: I totally agree. And not only that, by the Fed stepping in and providing liquidity in the markets, it's good for market functioning, but it also keeps borrowing rates low, which is critical to get us through this period for consumers and for companies to have access to funds to bridge this crisis and get to the other side.
Tim: So I think about our investors and one thing they don't want to do is sell into this. The corporations, they have to sell down and accumulate cash because they have demands on their business. As you mentioned, paying their employees, paying their power bill, etc etc. They've got a much higher burn rate than an individual. An individual hopefully has their cash reserves and then they can wait to tap into their other investments. So if you're selling into a liquidity crisis, you're probably selling at a distressed price. Fair enough?
Sara: I totally agree with that.
Tim: So maybe if they can, if you can afford to, better to wait then then to panic now.
All investing is subject to risk, including possible loss of principal.
There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
Diversification does not ensure a profit or protect against a loss.
Although the income from the U.S. Treasury obligations held in the fund is subject to federal income tax, some or all of that income may be exempt from state and local taxes.
VIGM, S.A. de C.V. Asesor en Inversiones Independiente (“Vanguard Mexico”) registration number: 30119-001-(14831)-19/09/2018. The registration of Vanguard Mexico before the Comisión Nacional Bancaria y de Valores (“CNBV”) as an Asesor en Inversiones Independiente is not a certification of Vanguard Mexico's compliance with regulation applicable to Advisory Investment Services (Servicios de Inversión Asesorados) nor a certification on the accuracy of the information provided herein. The supervision scope of the CNBV is limited to Advisory Investment Services only and not all services provided by Vanguard Mexico.
This material is solely for informational purposes and does not constitute an offer or solicitation to sell or a solicitation of an offer to buy any security, nor shall any such shares be offered or sold to any person, in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities law of that jurisdiction. Reliance upon information in this material is at the sole discretion of the reader.
Securities information provided in this document must be reviewed together with the offering information of each of the securities which may be found on Vanguard's website: www.vanguardmexico.com/web/cf/mexicoinstitutional/en/home or www.vanguard.com
Vanguard Mexico may recommend products of The Vanguard Group Inc. and its affiliates and such affiliates and their clients may maintain positions in the securities recommended by Vanguard Mexico.
ETF Shares can be bought and sold only through a broker and cannot be redeemed with the issuing fund other than in very large aggregations. Investing in ETFs entails stockbroker commission and a bid-offer spread which should be considered fully before investing. The market price of ETF Shares may be more or less than net asset value.
All investments are subject to risk, including the possible loss of the money you invest. Investments in bond funds are subject to interest rate, credit, and inflation risk. Governmental backing of securities apply only to the underlying securities and does not prevent share-price fluctuations. High-yield bonds generally have medium- and lower-range credit quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit quality ratings.
There is no guarantee that any forecasts made will come to pass. Past performance is no guarantee of future results.
Prices of mid- and small-cap stocks often fluctuate more than those of large-company stocks. Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility. Stocks of companies are subject to national and regional political and economic risks and to the risk of currency fluctuations, these risks are especially high in emerging markets. Changes in exchange rates may have an adverse effect on the value, price or income of a fund.
The information contained in this material derived from third-party sources is deemed reliable, however Vanguard Mexico and The Vanguard Group Inc. are not responsible and do not guarantee the completeness or accuracy of such information.
This document should not be considered as an investment recommendation, a recommendation can only be provided by Vanguard Mexico upon completion of the relevant profiling and legal processes.
This document is for educational purposes only and does not take into consideration your background and specific circumstances nor any other investment profiling circumstances that could be material for taking an investment decision. We recommend to obtain professional advice based on your individual circumstances before taking an investment decision.