Sure. Maybe I'll start with just what brought me to Vanguard. I'm often asked that question, and what I usually say is, I took the call because of the firm's reputation. Who wouldn't? I mean, Vanguard has an amazing brand, but I really took the job because of Vanguard's mission, people and culture. The mission, I think, you know, is to give investors the best chance of investment success. And I will tell you, we really live and breathe this every day. It's reflected in the people and the culture, and it's truly inspiring. I'm so proud to be part of the team. And when I reflect on the past five years and executing on our mission, you know, what I think about is, wow, I joined right before COVID And I think about all of the volatility that we've seen and to be able to execute through that on behalf of our clients has been an incredible journey. You think about COVID Silicon Valley bank, the Yen Carry trade on Wine Liberation Day. These are really moments where the team shines and we're so excited and happy about the strong performance that we're able to deliver to clients, and especially through periods of stress, really, when you need bonds the most. But if I really zoom out, I think you interviewed Saleem last year and he talked about our mission and how we want to disrupt in fixed income. And the mission being give investors the best chance of investment success. It really means to us, to give you the best chance of investment success means having bonds in your portfolio. And we really want to lower the cost and complexity of doing so. So the vision that I have really, for the fixed income group that we've been working on is to bring that Vanguard effect to all of fixed income. Morningstar actually coined that term, the Vanguard Effect, and we use it freely, but it really just means lowering the cost and complexity and bringing institutional quality bond funds for all investors. And. And when I say all of fixed income, I mean index and active funds and ETFs, public and even private one day. So what we've been doing over the past five years is to that end, we've had a strategic lean towards active management. We think the opportunity set is strong and active. We've been building capabilities there. We've also been leaning into ETFs, doing more there. You know, the growth and innovation in bond ETFs is really phenomenal. It's become the vehicle of choice for many investors. And then what's also cool is we're combining those and we're also doing much more inactive ETFs. And I really feel like we're kind of uniquely positioned to excel there. So that's what we've been doing. How we've been doing it is we've been investing in talent and technology. Talent here, Gosh, I got here. There's incredibly deep bench of experts, Vanguard veterans who've been investing for 20, 25, 30 years. And then over the past, you know, five years or so, we've been adding talent from the outside, just bringing in new capabilities, diversity of perspective, and we've really just put together a Phenomenal team. And on technology, I think like everyone else, we're really investing a lot in technology. You know, just really bringing in that state of the art technology to enhance every aspect of our workflow. And through these efforts of investing in talent and technology, it's enabled us to launch new products and grow our AUM. We've launched 23 new products in the past year alone. Most of those were ETFs, including active ETFs. We have 2.8 trillion in assets under management now. And that's up from 1.9 trillion when I became the head of the fixed income group. And last year we set our ETF cash flow record. So a lot of exciting new things. But I definitely want to emphasize that there are things that have not changed. And what has not changed is our laser focus on clients and performance. Our costs are low. Active funds, 98% are priced in the lowest decile of their category. Vanguard returned 350 million to clients last year in expense ratio cuts. And our performance has been strong. All of our index funds have tracked to their benchmarks and 85% of our bond funds outperform our peers on a 10 year trail. So that's like a really powerful performance and cost multiplier.
Sarah Devereux (7:24)
Sure. I think Bogle's mission really gets misunderstood. Sometimes people associate him with index, but his message was really about low cost. I think at the time though, low cost was synonymous with index because you couldn't do active at a low cost. And so we've evolved today through scale, through skill, through technology, we can do active at a low cost. And I actually think he would be quite proud of what we're doing. Maybe I'll go a little bit into our philosophy. We really do believe we have a differentiated approach to active fixed income. We call it our active edge. Our philosophy centers on really consistency over the long term. And we firmly believe that people and process result in performance. Great people, great process is great performance. And just to double click on each of those in terms of people, we really have a deep Bench a very team based approach as I mentioned, great foundation and we've been sprinkling in great talent externally. And it's a collaborative culture. We say we don't have star managers, but I think it's not quite the right way to say it. It's really all our managers are stars. We have an all star team and this is impactful for performance because it means our managers aren't competing with each other. We're really collaborating to make sure that the best ideas from that a team are getting in all of the portfolios. So I think that's really a differentiator. Also on the team, they're really focused. We don't have any SMAs. We have only 40 ACT funds in ETFs which means that the portfolio managers are fully engaged on those portfolios and not distracted by individual clients. And hundreds of SMAs that are behind that 40 act fund, which is the case with many of our peers. And there's complete alignment because the portfolio manager's success is measured by Alpha, not by AUM. So we do really feel that our PMs are aligned with our clients. And then finally in the people category, I'll put the technology there because our team is really supported by this cutting edge technology which scales their impact. So that's people process. Our active process is really rigorous and it's really disciplined. We go both top down and bottoms up. And there's risk management at every step of the way. We focus on repeatable and reliable strategies, strategies that have high information ratios. This way we hit a steady stream of singles and those singles compound over the long term. We're really vigilant about this. We are absolutely fanatical about prioritizing these strategies. We use what we call an alpha waterfall. At the top of the alpha waterfall are those strategies that are the most repeatable and reliable, the highest information ratio. And we've invested heavily in those strategies over time. For example, you're something like security selection. Right. Our credit research teams really can roll up their sleeves and have a very high hit ratio. And we prioritize those type of risks. And then, you know, the second thing that we do and the active process is we have a discipline around valuations, you know, and this is really something we can do. Our low fees really enable this because we can be patient, opportunistic. When sometimes high fee managers feel pressure to be risk on all the time to, you know, get over that fee hurdle, we can have more flexibility and just ensure that we have on the right risk at the right time. And the right size in contrast to fully risk on all the time. We're patient when you're not getting paid for risk, we'll take chips off the table, generate dry powder to deploy later when spreads widen, for example, in credit. And we're opportunistic so that when that does happen, we strike hard when the odds are in our favor, for example Covid and Silicon Valley Bank Liberation Day, times like that, we're really prepared to deploy capital and not just in a beta way, but at the alpha level, individual, you know, bonds and issuers that we think are attractive. And then finally we're true to label. And I think that's a differentiator. We want clients to trust that the funds are going to behave the way that they expect, no surprises. So that's really important. So putting that all together, that focus on the repeatable liable strategies, valuation discipline and being true to label, this is what results in that consistency. Right, Consistency over the long term. And that's what's ultimately led to that strong performance record.
Sarah Devereux (12:34)
Yeah, so we have an alpha waterfall that is customized to each fund based on what is the mandate, what are the alpha levers available, et cetera. And at the top of that alpha waterfall are those highest information ratio strategies and at the bottom are things that are less reliable. That's not to mean that we don't use those less reliable levers. It just means we should be able to fill up and hit our alpha target with the more repeatable ones and then use the ones at the bottom of the alpha waterfall more opportunistically. So for example, top of the alpha waterfall security selection, our credit research teams going company by company and doing relative value overweighting and underweighting based on valuations. And then at the bottom of the alpha waterfall, actually one more at the top that's on credit in the rate space. At the top of the alpha waterfall we have a lot of data driven strategies which have, we use AI and ML to generate signals that have a very high hit rate and we come to bat very often on those, those are very reliable alpha levers. And then at the bottom are things like, you know, trying to trade time rates, for example, trading duration we do it, but it's mathematically proven to have a lower Sharpe ratio or lower information ratio. So it's less reliable as a source of alpha. So we use it opportunistically. We don't have to rely on that in order to hit our alpha targets. We'll do it when the risks are more asymmetric. So hopefully that brings some clarity to the alpha waterfall.
Sarah Devereux (15:03)
Well, we think the ETF landscape is promising. Very, very much so. To your point, it's really become the vehicle of choice for many investors and it's really not surprising given low cost and some of the tax efficiencies and the liquidity profile. The marketplace has grown very quickly. It was about $2 trillion a decade ago and over $13 trillion today in the U.S. when I look at that and I look at fixed income, only about 20% of that $13 trillion is fixed income. And despite seeing new cash flow records, last year I think there was $425 billion or so in fixed income ETF cash flows, which is a new record. Fixed income ETFs still represent less than 5% of the overall fixed income market. So there's room to grow. We think there's room for ETFs to grow, there's room for fixed income to grow within ETFs and there's room for Vanguard to grow within fixed income ETFs. I would also call out active ETFs. We think they're. I guess at this point I would call them emerging. They're smaller, but growing very rapidly. Of the 144 or so fixed income ETFs that were launched in 2025, over 75% of those were active. They're also rapidly gaining adoption in 2025, 40% of the flows into fixed income ETFs went to active. And within active fixed income flows, overall ETFs are responsible for 60%. So I think it's something that we're going to continue. It's really a trend that's here to stay. It's great. And when I think about originally the first active ETFs and fixed income were just in that ultra short category, which is active, but it's less active. There's fewer alpha levers within that category. But in 2025, we've seen demand really broaden out to traditional active strategies, like off of the aggregate index and some of the core categories and income categories. So it's super exciting. And what's also exciting for us about active ETFs is we feel that we're really uniquely positioned to excel here because we've had that active fixed income team for over 40 years and we have that very strong track record and performance. And at the same time, we've also had a large presence in ETFs. We launched our first fixed income ETF. Most of the original ETFs were indexed right, but the first fixed income ETF we launched in 2007 had incredibly strong sponsorship, is now over 140 billion in size. It's the largest fixed income ETF out there. So we have this capability, this ecosystem around ETFs, a capital markets team, et cetera, that. That has a long history. So we're just thrilled to be able to put active capabilities and ETF capabilities together. It's a natural extension of our business and it really gives investors that increasing choice. I think you asked though, also, like, what would we not do in an etf? Which I think is a really good question. When we look at product development, we really have the same philosophy for ETFs as we do for all Vanguard products. And our lineup has really just evolved as client needs have evolved. But our goal is really just to ensure that we provide a broad, carefully curated lineup of solutions that are designed to meet the needs of our diverse client base and that have enduring investment merit. We're not going to go for that flash in the pan. So to that end, we've accelerated recently. We've launched 23 new products in the last year. 18 of them were ETFs. And that's just in a very rigorous process between the investment team, the product team and the risk teams to make sure that there's no alpha degradation, there's enough liquidity to be in an etf. Wrapper and is there enough transparency in order for the ETF to trade well in the secondary market? So all of these things together are part of the decision making process. We really feel strongly about everything that we've launched to date and, and at the same time we're always investing in new capabilities such as technology, et cetera, that are going to prepare us for future innovation because we do think that the ETFs are going to continue to grow.
Sarah Devereux (19:40)
Yeah, I think there's a couple things I would think about. First of all, when you look at the index, how it's evolved, starting with the AG, for example, it used to be only 20% treasuries, now it's 40, 45% treasuries. So when you're comparing yourself to the AG of today versus the AG of yesterday, you might want to underweight some Treasuries to go into other sectors. So I think that's an interesting concept. But in addition to that, there are also a lot of sectors that are not even in the index. A lot of structured products are outside the index, et cetera. So you know, our active teams are going to be trying to incorporate all of that into their thinking. And then within, you know, the typical products, let's say, you know, you think about ig, you think about structured products, you think about high yield, et cetera, there's varying degrees of ability to generate alpha within each of them. Areas like high yield, for example, we really lean heavily into active management there because the index itself can have quite a bit of risk in it from just a pure beta perspective. So from time to time, even if we're neutral on high yield, like we're neutral on the beta and our overall view of the sector, we still find plenty of alpha opportunity because of the dispersion inequality and the dispersion in valuations that we're able to monetize and overweights and underweights and still drive alpha. So there's quite a bit of opportunity in areas such as that.
Sarah Devereux (21:49)
Yeah, so private credit, the credit landscape has evolved and it's really fascinating and I think it's a, a good way to understand it is to think about the reasons why it evolved and how it evolved. And private credit is grown over the past decade to, and I'll just talk about direct lending, just to keep it simple, about 2 trillion in size. And that's a really rapid growth. And the reason it grew was we were at the zero lower bound for so long and the private equity boom was funded by, by low funding. When you can fund it effectively, zero. And that created private credit on the supply side. And then at the same time with the demand side, there were a lot of investors who were just not getting a lot of yield, who were seeking yield. And so they started being willing to do extra work and go into different parts of the market to get that yield. I personally thought when rates backed up once IG credit got to over 4% that people would back away from private credit. Too much work. Let's just go right back up in quality to IG credit. And I'm the First Amendment. I was wrong. You know, people stuck around in private credit and I think there's real benefits there. What's turned out is, you know, you get higher return, you get a different risk premium in the form of liquidity, you get diversification. And so it is compelling. And for suitable investors now note, less liquid, less transparent. So you want to size it right in your portfolio. But we do think it's here to stay. And it's been interesting to watch how private credit has evolved. The key considerations, I would just say though is that illiquidity premium has compressed private versus public. You picked up 5 or 600 basis points. Now it's maybe 200 basis points. And the credit quality and resilience through downturns does remain a watch item.
Sarah Devereux (24:00)
Oh, it's such an exciting time in technology, especially in fixed income. You know, fixed income is really different than equities. Bond market is so complex and opaque. Millions of securities and it trades over the counter. Right. Not on exchange. So there are, there are so many applications and use cases and that emerging technology is really an accelerating trend. Just to. If I were to think about a few things where there's been rapid advancement that really impacted the broad bond market, I would say electronification, automation, Data, data analytics, ETFs are all interconnected. If fixed income trading is really increasingly electronic, in treasuries I think 2/3 are traded electronically, and in credit it's a little over half. And that's actually increasing pretty rapidly. And that electronification is really impactful because it results in more efficient buying and selling of securities, better price discovery, better liquidity, lower transaction costs. And it also creates vast amounts of data. Right. And then that data enables advanced analytics and increasing automation. And that automation and data analytics supports optimized decision making and trading efficiency. All of which link back to the ETFs. As I mentioned, 2025, we saw that record breaking year in fixed income ETF launches, but it was record in flows, it was a record in trading. And there's a real growth in the product availability. And those ETFs are covering finer and finer segments of the market. This creates a tool for greater access to finer and finer parts of the fixed income market. And at the same time, this disruptive power goes even a level deeper in how it impacts the underlying market, particularly how it relates to portfolio trading. Right. So as market makers have grown their ETF trading, it's enabled just a greater volume in that portfolio trading, even electronic portfolio trading, which is growing rapidly and that just increases flexibility in managers in their portfolio. So overall we're super excited about technology and what it can do to aid investing. I would caveat that we really see it as not a substitute for our portfolio managers, but as leverage for them, a way really scale their ip. And as an enabler, we believe in that augmented approach, always having a human in the loop. And it creates more time for our PMs to spend on those intellectual activities and then they can spend less time on operational activities. So we're super optimistic about it. I'm happy to double click if you'd like a little bit on our technology roadmap and specifically the kind of things that Vanguard's investing in right now, if that's helpful.
Sarah Devereux (27:06)
Sure. So yeah, maybe my comments will I could bring them to life with some of the things that we're doing currently. So we're really investing in that technology to enhance the portfolio managers. It's critical to our ability to deliver performance at scale across both index and active. And we have three strategic investment pillars that really span our entire investment process from end to end, enhancing every aspect of our portfolio managers and traders and research teams workflow. The three pillars are enhanced insights, faster decisions and optimized execution. So I'll double click on those on enhanced insights. Think about big data, right? We are creating proprietary tools that consume big data. They use AI and ML to generate relative value signals, right. These are those data driven insights that are repeatable and reliable. Top of that off a waterfall systematic strategies that we can capture that relative value and generate alpha. We're also using in the insights category generative AI to draw insights from earnings reports for example is phenomenal leverage for our credit research analysts. So as insights, the second pillar is faster decisions. This is where we use we have an advanced optimization engine. Optimization is that sort of mathematical concept and it really helps us generate these complex portfolios to make decisions very quickly. What makes it really powerful for us is that it's not just an opto engine. It's integrated with our relative value tools and our liquidity aggregator tools. So it really just enables the team to put that money to work faster and effectively helps us scale our ip. One sort of concrete example for that one is it's helped us to cut our ETF basket creation turnaround time. It should take us two hours sometimes to do an ETF basket. Now it takes 10 to 15 minutes. So that's been a real enabler. And the final pillar is optimized execution. I mentioned earlier, fixed income is really different than equities. It's more fragmented, difficult to source. And so we have tools that make that easier for us. We have tools that streamline dealer quotes, convert into actionable trades liquidity aggregators. As an example, on our Muni team, Our aggregator consumes 4 million quotes a day and turns it into about 100 actionable trades each day. So that's been a real game changer for us. And then sort of outside our pillars but alongside we have what I call this experimenting Bucket. We're always running experiments with cutting edge technology, things that are new AI ML. We're currently partnering with IBM on a quantum experiment that we're applying to that portfolio optimizer. So there's a lot going on. Hopefully some of those examples where we're investing kind of bring it to life.
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Sarah Devereux (33:30)
Diversified portfolio, yeah, I think we do believe that bonds are an effective diversifier to equities. It doesn't hold every minute of every day, but it holds over the long run. And I think when we're in this environment now, when we have the higher income, they're in a position to do that again. When bonds were at the zero lower bound, they were pretty unattractive. And we were there for a while, right. You know, we had better part of a decade after the GFC when yields were very low. And so you didn't have any components, you didn't have a great return. But also the price action couldn't be symmetric from there. When you're already at zero, it's hard for rates to rally, right? So the price can't rally. And then when rates back up in 2022, there was no cushion. And I would contrast that to today when we're back in a more normal environment where you have that income today, what you get is that ballast where bonds can rally. And if bonds sell off, you have a head start. Just to do the simple bond math, you have a 5% coupon on a 5 year bond, it could back up 100 basis points and all you would lose is one year's worth of income. I think that that ballast is there. Now you're asking about a specific instance and a few times over the past year or so where we've seen some price action where bonds sold off. And I think in those cases they're volatile periods where it doesn't hold the whole time. But you look back example for Liberation day last year, by the time we got to the end of April, bonds were up 3% or 4% in the year and equities were materially lower. And so even there's that intermittent volatility, it still ended up being a great year. And the diversification benefit was there in the end. The thing to keep an eye on that we have as a watch item is that term premium. So when we're talking about the ballast benefit of bonds, what I'm talking about on average over time and what's on average? Well, what's the ag? That's the six year duration. Okay. What I'm not talking about is the 30 year long bond. The 30 year long bond can have a bit of a life of its own. And so when we're talking about the term premium, how the term premium can steepen, that's going to be a risk that's going to be around. As long as we have high deficits and people start talking about the supply and demand of US Treasuries, that comes into question. And the long end of the curve can be sensitive to that. Now I would call it some mitigants on the term premium steepening out. We've seen spikes in that it usually has proven to be a buying opportunity. But we acknowledge it does remain a risk and will be volatile. The mitigants that we think about are that first of all on the deficit, I don't know, you want to call them the bond vigilantes. They're not hibernating, they're still watching and they haven't really been coming out that often. But the deficit itself is high. But people are talking more and more about our ability to grow our way out of it. The AI boom and the high growth forecast for this year, people are starting to get a little more comfortable around the edges of the possibility of growing out of the deficit. So that's one mitigant. The second mitigant is just that that term premium has repriced a lot. When the Fed started cutting rates In September of 2024, from then until January 2025, just a quarter Fed cut 100 basis points, race backed up the 10 year backed up 100 basis points. So that term premium really increased. I think it's. If you look at the ACM term premium it was negative for a long time and now It's a positive 80 or so. So about 100 basis points more in term premium. And in a world where everyone's talking about Risk premiums being compressed, spreads are tight, equity market valuations are high. Wow. What's the one place where risk premiums are actually higher? The term premium. So that's another mitigant that maybe it's priced in. Maybe that price action could be more symmetric from here. And then the third one, which I think is really important right now, is that the administration really has their eye on the term premium, that tenure point of the curve Secretary Bessant called out explicitly early last year. And with the focus on affordability right now we expect there to be continued focus and the administration's shown that they're willing to take action. We saw them recently say they're going to have the GSEs buy mortgages. And then I look at last year, they called out the ten year. There were many, many steps taken to really bolster and ensure that supply, demand, balance of Treasuries is good and healthy. There were many steps taken and guess what? After the term premium peaked in January, it stayed pretty stable over the course of the year. So I would expect that focus to continue. If we see any material spikes in long end rates, I would expect some action.
Sarah Devereux (39:04)
Yeah, so I think when I think about this year, we do think it is going to be another good year for fixed income. We think this year is really going to be more about that income and less about price appreciation. We do think yields are going to be range bound. We think the ballast will be there if it's needed. Our base case is positive for risk assets, but our risk case around that, I would say the economic risk case is really keeping our eye on the labor market and if that were to weaken, we would expect the Fed to cut more. The other thing on the downside that we're keeping an eye on in terms of the economic environment being supportive of risk assets is the AI Capex theme. If there's any kind of stumble in the spending for AI growth We could see that as an equity drawdown, that we would also expect rates to rally there. And then on the other side, where we're considering what would be the higher rate scenarios, we think there's lower probability of that. Because when we look at inflation, which would be a driver of higher rates, usually we think about, gosh, that what's driving this growth being stronger is AI. And if AI is driving stronger growth, there's productivity that comes alongside that. So we're less concerned about the rates up due to an inflation scare. And so the balance of risks we would say are to that more of a slowing growth scenario where there could be more Fed cuts if needed. But our base case is actually very strong. We have a strong growth outlook, moderating inflation, bit sticky, but the tariffs will roll off and the labor market in our base case will stabilize. But we do, you know, we're really keeping an eye on that labor market that does present some risk to the downside.
Sarah Devereux (41:23)
Yeah, we are. We have, you know, we have pretty reasonably high odds on our base case and we have more odds on the downside then the upside. When we're looking at just to double click into inflation a little bit, we're looking at really the tariffs from last year and that they're carrying over into this year. Well, first of all, they could go away. We'll see what happens with scotus. But in the second half of this year, what's going to happen is the base effects are going to kick in. The tariff impact is finite. And we think the Fed is divided. And there are two camps of the Fed. One camp is saying inflation's been above target for five years and counting. The other camp is saying, well, it's going to go away once this tariff base effects kick in and the tariffs fade. We're more in that camp but on the labor market, and I look at the Fed and the camps, there's some that are worried that the labor market's going to get tight as this growth comes through because the labor supply is so low. And if there's demand, more demand than there is supply, that could drive down the employment. We don't see that as much to the upside, but we do worry about the labor market rebalancing the risk to the downside. And that's really just because the labor market's been rebalancing. It's at a fragile equilibrium. To date, both the supply and the demand of labor has come down pretty much in lockstep. So the unemployment rate has stayed pretty steady. But when you look at it on the demand side for a while, there were two jobs for every one person who wanted one. We look at the beverage curve, right? Job openings, two jobs for every one person is down to one job for every one person. That's a cuspy point on that beverage curve and could easily overshoot. And so we snap out of that. No hire, no fire into a fire zone. And then on the supply side, from immigration and just demographics, the labor market's a lot smaller. You know, when you think about last year, the payroll growth was usually, you know, on an unusual non farm payroll. Friday would be around 150 on average. Now it's, I think the last print was 50. We think it's going to go to 40 as that break even rate. Right. That's small when you're that close to zero. There's a non zero probability, in fact, it is likely that we will see at least one, if not a couple negative payroll reprints this year. And it's hard to imagine that the Fed won't react to that. So that's the balance of risk. The main factors that we're really considering around our base case.
Sarah Devereux (44:09)
Sure. So when we talk about the policy crosswinds, I think the headline is what we expect is that the 2025 headwinds are going to be offset by 2026 tailwinds and that it will be a net positive. Now that doesn't mean that the winds aren't going to shift day to day. When you get your morning weather report and you're like, oh, what's the news say today? What's the weather report? It can shift around, but we think, look through the noise, focus on the long term net net. We believe this year will be more positive. So specifically think about trade policy. Trade policy tariffs were a headwind in 2025 big time. There was a tariff roller coaster, but it was like sort of that driving macro theme for the era and was a headwind. We've seen tariffs flare up again recently, but does not change our overall thesis that the tariff impact is going to be lower in 2026 than it was in 2025. So that is the primary headwind that we think is going to be offset by tailwinds such as fiscal policy. The OBBB is kicking in. We think that boosts growth on the order of 40 basis points. We see deregulation as a major tailwind. And then the monetary policy, we've got cuts already in the bank. Those are going to continue to flow through into the real economy. And then there's the potential for more cuts from the Fed should the labor market weaken.
Sarah Devereux (45:48)
When it comes to credit, I would say public credit fundamentals are very strong. The challenge is that spreads are tight, right? But I would say also spreads are tight for a reason. Balance sheets are strong, fundamentals are strong. There's a reason spreads are here and they could stay here for some time. But with spreads tight, it's going to take more diligence and precision to extract the value. And what we're hearing more and more from clients is they're asking. There were some pretty high profile incidents of private credit market last year and clients are asking, is that the canary in the coal mine for what's to come? When I look at those, I see them as idiosyncratic, not systemic. Some of them are related to fraud, for example. But I would say that private credit could be the place where we would see the turn in the cycle first. We don't think we're there yet, but typically what happens is you first see the turn of the cycle down in credit and overall it's just a reminder that due diligence is critical, cycle's maturing, and with spreads being tight, valuations are full, there's not a lot of room for cushion. And that is especially true down in credit quality. You talk about spreads, people, credit spreads are tight. What are we talking about? We're talking about the spread over Treasuries and when you look at the IG spread over Treasuries, sure, that's tight. But then when you look at the spread to go from IG to high yield and the spread to go from high yield to private credit, that is also compressed. You're not getting paid a lot to go down in credit and take on extra risk and so that is what's motivating our teams to stay up in credit. We have a up in quality bias. We are super focused on security selection as always. It's, it's a high information ratio strategy. It's the top of our alpha waterfall always across the board, especially in high yield. And then finally we are holding some dry powder deploy should spreads widen from here. I do want to take a quick second though while we're talking about because we were talking about the landscape of credit evolving earlier. And I think as much as private credit's evolved and developed and grown, public credit has two the public market credit quality is higher today than it was two decades ago simply because of a compositional shift in the market. When you look at high yield prior default cycles, 2016, the energy and 2020 with COVID those default cycles flushed out those weak borrowers and some of that riskier lending has migrated to private credit. So when you look at the index now, the whole high yield universe, the double B part of that is now 50% of the index and in 2007 it was only a third and triple Cs are only 11% now and in 2007 they were 22%. So when you're thinking about spreads and that time series, it's really not apples to apples versus history because the credit quality is better. And we think this actually accounts for about 50 basis points, a spread differential in the high yield market. But nevertheless the overall theme is security selection matters, especially down in credit. And so we're really leaning in there.
Sarah Devereux (49:20)
So absolutely, AI CapEx is a major macro force. It is Central to our GDP forecast. It added about 50 basis points to our GDP forecast this year. And to date most of that capex has been funded by free cash flow. But what we're seeing more recently is that the hyperscalers are issuing debt. This is doing two things. First of all, it's increasing leverage to the AI trade and it's also increasing supply to the bond market. We saw about 100 billion in hyperscaler specific issuance in late 2025. That was only about 20 billion from them in 2024 and in 2026 we expect close to 400 billion of issuance. Now that's not just hyperscalers, That's a broad AI related issuance, but that's material. It's about 15% of the total IG issuance that is expected this year. So this is a technical, we think this is a technical that will create opportunity because most likely this increase in supply could put some pressure on spreads. Maybe not permanently, but these are big deals usually and there could be some indigestion. But the good news is when we look at these issuers, they're very high quality issuers with very strong balance sheets in general. So we'd expect there would be an opportunity if there's a technical widening, we'd see it as an opportunity to add that very high quality credit. Of course being selective name by name. As I mentioned earlier that security selection's important and then the bigger theme I think over the long run is if you zoom out as time passes, this is going to be a much bigger part of the market. It could be a whole entirely new sector in the fixed income universe and it will extend to different sectors power needs. We could see issuance in munis going up. So we think there's just going to be an incredible opportunity for our active teams to add value through discipline analysis and we're pretty excited about it.
Sarah Devereux (51:53)
We definitely watch technicals and I think technicals are going to matter a lot in 2026 because we expect both heavy supply and heavy demand. On the supply side, we do expect it to be heavy as discussed earlier. AI Capex is part of that. But overall we do expect very heavy issuance in fixed income and we've seen that to start the year. It has been very well sponsored and that's what we expect will continue to happen. There's a deep bid for fixed income. It has been all the supply to date. Record supply has been easily absorbed by robust investor demand and oversubscribed deals. Trading great in the aftermarket, not a lot of new issue sort of discounts, et cetera. So far so good I would say. Another observation that we have comes from our client base. At Vanguard, we serve individual investors and their advisors and we are seeing very strong demand for fixed income. And the demand we're seeing is starting to go out the curve. And I'll share some stats around this because I think it's kind of interesting when you think about the yield curve. It was inverted for two years, right? That is the longest yield curve inversion in history. And that meant that investors got used to hanging out in cash, right? It felt pretty good to be in cash. There were great returns for an extended period of time. And now cash rates are dropping and the curve is steeper. And what we're seeing is investors who are going out the curve. So just to share some stats, 2023 through 2025, fixed income overall industry wide had over a trillion in inflows each year. In 2023, 80% of that went into money market funds. Like those are fixed income, right? But 80% of overall fixed income inflows were into money markets this past year. In 2025, industry wide, it was more like 50 50. But at Vanguard, what we saw are individual investors and their advisors. Omix was 2575. So we are still seeing good inflows into money markets. We're seeing good inflows overall and they're accelerating the back half of the year and the mix is going further out on the curve. So I think that's a really positive technical overall and we would expect it to continue even with the cuts. So far, hash rates have dropped, but the Fed continues to cut rates and that income and that part of the curve goes away and that term premium is now steeper and you get paid for going out the curve. We expect that to be a very favorable technical.
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