Sustainable, Responsible &/or ESG Policy:

Please refer to the answer provided regarding the “Overview” section.

Process:

The investment approach for our fixed income SRI fund is based on the below exclusion process:

• Bloomberg - provides the benchmark.
• MSCI - identifies the securities for exclusion.
• Vanguard - given the excluded securities, uses sampling to track the broad market.
• Investor - gains broad market exposure with SRI exclusions.

The Vanguard SRI Euro Investment Grade Bond Index Fund seeks to achieve the performance of the Bloomberg EUR Non-Government Float Adjusted Bond Index, which includes euro denominated investment-grade fixed-income securities, excluding Eurozone government debt and government related bonds, with maturities greater than one year.

The fund attempts to:

• Match the risk factor exposures of the index by investing in a representative sample of the securities that make up the index, excluding any securities which do not meet socially responsible investing criteria. The criteria take into consideration environmental, social and ethical factors as determined by the index provider and exclude component securities that violate UNGC principles and securities of issuers that are involved in making controversial weapons and tobacco products.
• Remain fully invested except in extraordinary market, political or similar conditions. The SRI screening process, which excludes index constituents that are or have engaged in activities that result in serious violations of the UNGC, is consistent with the characteristics promoted by the fund. For further information on the fund’s objectives, please refer to our website.

Given fixed income market structure dynamics, pure index matching is usually not practical for broad, well-diversified fixed income indices (such as aggregate or credit benchmarks), which may contain thousands of underlying securities. For these indices, we believe it is more effective to match the primary risk factors, such as those presented below, taking a sampling approach.

• Our objective is to match the benchmark return and risk after fees.
• We aim to match the benchmark for all primary and secondary factors.
• All positions and risk factors are reviewed on a daily basis.

Fixed income index portfolios are managed using a daily, disciplined and tightly risk-controlled investment process. This ensures minimal tracking error and consistent performance relative to benchmarks. The Fixed Income Group (FIG) uses third-party order management software, Aladdin, which combines risk analytics with portfolio management, trading, compliance and operations capabilities to allow efficient straight-through transaction processing.

FIG’s daily investment and trading process is described below.

Start-of-day input

The following controls and activities are performed by our portfolio managers:

• Client activity: Portfolio management receives daily cash flow activities.
• Holdings reconciliation: RMG and middle office reconcile holdings and cash balances.
• Index updates: Portfolio management incorporates index changes into the rebalancing process in order to stay closely matched to the benchmarks.

FIG also reviews the portfolio’s characteristics to identify if any thresholds have been exceeded, which would indicate that trading is required. Intraday cash activity and instructions from Vanguard’s other geographical locations (also known as pass the book) may also make trading necessary.

Research

Credit research resources

Vanguard has a dedicated credit research team within FIG. The specialists in this department evaluate the creditworthiness and relative value of corporate, sovereign and municipal issuers. As we typically track broad fixed income indices containing thousands of securities via a sampling approach, the work of our credit analysts plays a vital role.

To make informed decisions about the short and long-term outlook for credit markets, credit analysts refer to a number of external research sources, including:

• Standard & Poor’s
• Moody’s Investor Service, Inc.
• Annual reports
• Daily online credit reviews and outlooks
• Live webcasts

The team evaluates financial and credit trends across sectors, as well as for individual issuers in which Vanguard invests (or expects to invest). Credit analysts perform an objective, thorough and independent analysis of an issuer’s overall creditworthiness for those securities. This research process may include:

• Analysis of the issuer’s recent and historical financial statements
• Sensitivity testing on projected cash flows
• Discussions with management and/or rating agency analysts
• Site visits
• Road show presentations

FIG incorporates the views of our credit analysts within the issuer selection process.

Portfolio review and construction

FIG uses Aladdin to facilitate portfolio construction and risk management. All of the benchmark indices are available within Aladdin, which ensures quantitative analyses and portfolio analytics are run on a consistent and comparable basis.

FIG continuously reviews risk factors to ensure our portfolios closely track their respective benchmarks. Risk factors we seek to match include duration, yield curve, convexity, country and currency exposure, sector and industry exposure, credit quality exposure and issuer exposure. In addition, we examine risk in more detail as we disaggregate the above major factors into sub-factors. For example, as we examine our corporate exposure, we monitor option adjusted spread distribution, capital structure and duration times spread.

FIG uses Aladdin to determine which credit risk and government bond exposures need to be adjusted versus the benchmark, to match the index’s key risk factors. Issue selection is as follows:

• Credit bonds: Once credit risk factors are determined, FIG incorporates our analysts’ assessments of credit trends, event risk and performance outlook to select the individual issuers that will address these risk exposures.
• Government bonds: Once the required characteristics are determined, FIG identifies the investable universe of government bonds with these characteristics and then performs a rich/cheap analysis versus the fair value curve. As we adjust the portfolio to align it to the index for interest rate and curve risk, we buy bonds that are cheap and sell bonds that are expensive.

Aside from Aladdin, FIG also uses a variety of quantitative tools provided by our counterparties, such as the Bloomberg PORT Global Risk Model and Optimiser. In addition, we use FactSet, a centralised system for performance attribution and risk analysis, as well as additional in-house proprietary models which enable monitoring, analysis and risk management.

Buy and sell discipline

For Vanguard’s passively managed index funds, our buy and sell discipline is applied with the objective of maintaining portfolio holdings that match the risk characteristics of the benchmark as closely as possible, thereby minimising tracking error. Portfolio managers are responsible for security selection and portfolio construction, working as part of a team and basing their decisions on comprehensive buy/sell decision rules.

Fund investment decisions are a function of a daily analysis of cash flow (e.g. subscriptions, redemptions and dividends), corporate actions and index changes. Additionally, portfolio managers review daily reconciliation and deviation reports (which compare each portfolio’s positions to its index), as well as each fund’s risk/return profile. When required, securities are traded using proprietary software to bring portfolios back into line. Vanguard has several layers of monitoring and uses risk controls to ensure portfolios track their indices appropriately.

Our investment framework was created to minimise costs, risks and tracking error and to take into consideration future events. Vanguard’s portfolio managers work within set policies and guidelines; any deviation must be justified and have clear rationale. RMG evaluates performance and risk characteristics of all portfolios and works closely with the portfolio managers to help ensure that risks are understood and are managed in accordance with established guidelines.

PRD works in conjunction with each fund’s board of directors to monitor portfolios, ensuring portfolios adhere to defined objectives. The team reviews performance regularly – generally on a weekly, monthly and quarterly schedule.

Derivatives usage

Vanguard does not use derivatives for leverage or speculation. We use derivatives only in circumstances where they offer the most cost-effective means of improving a portfolio’s risk profile. We always compare the cost of the derivative to the cost of constructing an equivalent position in traditional securities. We take a conservative approach to the use of derivatives and operate with closely monitored internal maximum limits.

We use a number of systems to manage derivatives. Software applications from third parties and those developed on a proprietary basis are used for trade execution and position management. Also, derivative positions are incorporated into portfolio management systems that manage a fund's positions as a whole in both derivatives and conventional securities. Our fund accounting department monitors daily contracts and margins.

A team process guides the trading and monitoring of our derivatives positions. Many eyes are focused on derivatives exposures, to ensure that the portfolios’ positions remain within the agreed-upon tolerance levels, including the following:

• Index portfolio managers
• Index traders
• Dedicated derivatives traders
• Risk management group

For our fixed income portfolios, futures, options, swaptions, caps, forwards, interest rate swaps and credit default swaps may be used for duration, yield curve, credit risk, volatility and FX management. We have expertise in their application and risk management.

For our equity index portfolios, we typically use futures contracts, which allow us to remain 100% invested while freeing up cash for efficient portfolio management purposes (e.g. rebalancing, transitions). A good example is the reinvestment of dividends paid to the fund. Using futures contracts allows dividend receivables to be invested until the dividend payment date; this enables the funds to apply the index methodology consistently, limiting tracking error. Depending on the portfolio, we currently use different contracts, which we trade on a recognised exchange, for example S&P 500, FTSE 100 and Topix among others.

We collateralise derivative positions at or exceeding 100%, subject to the minimum transfer amount. Appropriate collateral instruments include government, corporate and asset-backed securities. The required amount of over-collateralisation increases for non-Treasury securities. Vanguard’s fund accounting department maintains the collateral, with market prices used to value the securities.

Index selection

We have a rigorous approach to benchmark selection. For index funds, our experts select a benchmark index based on how accurately it tracks the returns of the designated market segment. Some examples of the criteria we consider include index coverage, construction rules, rebalancing and cost.

We use float-adjusted indices that:

• Represent actual liquidity in the marketplace
• Better capture the investable universe
• Reflect best practice in indexing

Given our history and deep investment experience in managing index funds, we have identified certain criteria – or best practices – in selecting a benchmark, such as construction rules, adjustment for float, approach to market capitalisation, rebalancing and the market impact cost. As a firm, we have a long history with many providers such as FTSE, CRSP, MSCI, S&P, Russell, Barclays and even bespoke benchmarks for certain select objectives (e.g. a high dividend product).

On the fixed income side, we have partnered with Bloomberg Barclays primarily, which has provided building blocks to produce a global allocation to the investment grade universe. In addition, we switched to Bloomberg Barclay’s float-adjusted benchmarks in recent times; these benchmarks reflect the true liquidity of a given segment of the market as central banks have engaged in quantitative easing and taken securities private.

Equity mandates have a wider range of providers and we have diversified our use over the decades.

MSCI originally provided the building blocks for the UK-domiciled and Ireland-domiciled funds to reflect a global allocation across developed and emerging markets. We began partnering with FTSE in 2000 on SRI funds, with the launch of a fund for our US clients.

Rebalancing considerations

Our funds track indices that rebalance at month-end. Correspondingly, our index funds also rebalance at that time, to account for any changes and ensure our funds closely match the index (e.g. in terms of duration and curve exposure). We also reinvest any principal and interest at the time it is received during the month.

Because new issuance occurs throughout the month (not necessarily at month-end), FIG exercises discretion as to whether to participate in the primary market, or to buy the bond in the secondary market at some point in the future. This flexibility is crucial in adding potential incremental returns, as new issues are not included in the benchmark until month-end.

In making the decision, the portfolio managers and dedicated traders have in-depth discussions with our team of credit analysts and conduct relative value analysis (comparing outstanding issues of that issuer with those of similar issuers). Through our analysis, FIG may determine that investors are better served by buying the bond post-issuance if the pricing offers no concession to comparable bonds. Alternatively, FIG may believe that the bond’s spreads will tighten (i.e. bond price will rise) by month-end, in which case investors would benefit by participating in the new issue.

Resources, Affiliations & Corporate Strategies:

ESG resources, roles and responsibilities: Vanguard does not have one central ESG team. Instead, we have various teams and groups tackling the different aspects of ESG. Please see details below on some teams responsible for various ESG considerations at Vanguard:

ESG Team, Portfolio Review Department

Regional ESG teams act as centers of excellence that deploy subject matter expertise and partner across the Portfolio Review Department (PRD) and cross-functionally to drive the success of clients and the business in each region. Each region’s ESG team is responsible for broader ESG investing topics, such as regulatory impacts, ESG product methodology and ecosystem enhancements, and enterprise-wide ESG strategic initiatives. 

The regional teams stay connected on global initiatives such as ESG data and reporting, industry trends, and ESG product roadmaps. The teams closely collaborate with partners across PRD, including colleagues in manager search and oversight and other product category teams. Many members of these teams commit a significant portion of time to ESG efforts as well, such as assessing the ESG competitive product landscape to inform new ESG product design and evaluating active managers on their ESG integration approaches.

In addition to ESG-dedicated roles, Vanguard continues to embed ESG considerations into existing functions to ensure ESG factors are considered alongside other matters to improve the investment outcomes of our clients.  

For example:

• Vanguard Fixed Income Group assesses the financial materiality of ESG risks to complement the standard credit assessment. FIG’s credit research analysts also regularly meet with issuers to discuss key credit risk topics and, where applicable, raise ESG concerns.
• Vanguard Investment Management & Finance Risk (IMFR) team provides independent oversight and monitoring of sustainability risks.
• Vanguard’s Investment Strategy Group (ISG) conducts research on both non-ESG and ESG topics which is then shared internally for education and to inform decision-making. This research may also be published.

ESG governance structure and responsibilities: In Europe, internal governance of Vanguard’s ESG-related policies and approaches, including its European Investment Sustainability Risk Policy occurs through an integrated structure of boards, senior leadership, committees and functions.

Vanguard’s European Boards oversee risk management (including ESG-risks) within Vanguard Europe’s overall business strategy, governance framework and risk appetite and across various departmental functions (including compliance, fund accounting, financial reporting, fund administration, investment management, investment stewardship, legal, and portfolio review).

At a functional level, the ESG SteerCo provides day-to-day oversight of ESG initiatives within the European business to ensure full compliance with ESG regulations and delivery of projects within its scope (including tracking progress, making key decisions, fielding escalations, providing guidance and approving reporting).

Affiliations, Membership and Involvement with Groups:

• UN Principles for Responsible Investment (2014; Signatory) Vanguard’s most recent Public Transparency Report can be found on the UNPRI website.
• Commonsense Corporate Governance Principles (2016; Open letter founding signatory)
• International Financial Reporting Standards (IFRS) Sustainability Alliance [formerly the Sustainability Accounting Standards Board (SASB) Investor Alliance] (2016; Member)
• International Sustainability Standards Board (ISSB) Investor Advisory Group (IIAG) [formerly the SASB Investor Advisory Group] (2016; Member)
• The Investment Association (2016; Member)
• Investor Stewardship Group (2017; Founding signatory)
• Task Force on Climate-related Financial Disclosures (TCFD) (2017; Supporter)
• CDP (2018; Capital markets signatory. Vanguard subscribes to data for CDP Climate Change, CDP Forests, and CDP Water)
• International Corporate Governance Network (ICGN) (2019; Member)
• Asian Corporate Governance Association (ACGA) (2021; Member)
• Institutional Investors Group on Climate Change (IIGC) (2021; Member)
• Investor Group on Climate Change (IGCC) (2021; Member)
• Asia Investor Group on Climate Change (AIGCC) (2021; Member)
• Stewardship Codes: The UK Stewardship Code (2021; Signatory)

SDR Labelling:

Not eligible to use label