Meet the $625 billion bond king you’ve probably never heard of

Josh Barrickman. Vanguard
  • Josh Barrickman is the principal and head of bond indexing in the Americas for Vanguard.
  • He oversees $US625 billion in fixed-income assets, the most of any bond manager in the world.
  • Vanguard is known for its passively managed index funds, but investing for the firm is much more active than one would think, Barrickman said.
  • He said there’s a role for actively managed bond funds, particularly in niche markets.

NEW YORK CITY — He’s the bond king you may have never heard of.

Josh Barrickman, 42, oversees $US625 billion in fixed-income assets for Vanguard. That includes the world’s two largest bond funds: the Vanguard Total Bond Market Index Fund and the Vanguard Total Bond Market II Index Fund, with $US190 billion and $US139 billion respectively, according to Morningstar.

The nearest competition, PIMCO’s Income Fund, is legions away, with $US99 billion.

The assets Barrickman manages are in passive funds, and, as he tells it, managing a bond index fund is nothing like running one for stocks. He got his start working in active management, however, a skill set he says helps him today.

We recently caught up with Barrickman to get his views on bond markets, how passive behemoths like Vanguard are changing markets, and what it’s like to oversee so much money.

This interview has been edited for concision and clarity.

Rachael Levy: I’d be interested to hear about what you do on the fixed-income-indexing side, and I’d also be curious about what misconceptions you think people have about what you do.

Josh Barrickman: Usually when I talk to people about fixed-income indexing, I sort of lead off with the difference between equities and fixed income. That’s probably the biggest misconception, that indexing on the fixed-income side looks like equity indexing, where you can fully replicate a benchmark, something like an S&P 500 — you can file 500 stocks in the right proportions and get very, very tight tracking on the index.

On the fixed-income side, because of the way the market is structured, where it’s more of an over-the-counter market, not exchange-traded, you have thousands and thousands of securities within a given index. It’s not feasible to fully replicate or really even get close to full replication.

So you really rely on sampling to get a selection of bonds that can mirror the risk characteristics of a benchmark and hopefully deliver a return relative to the benchmark that’s very, very close.

The way we do that is we use a team of specialist traders who break up the market into finer subsections and do their best to build samples within those subsectors that are very representative of the index, of that slice of the index. Try to do it in a way that’s as cost-effective as possible. There are transaction costs involved.

So it’s really, in a way, kind of a much more active process than people would think. There’s not an ability to fully replicate.

So it’s really, in a way, kind of a much more active process than people would think.

It’s about identifying the risk factors of the benchmark. So things, like: What’s the duration? What’s the curve look like? What’s the sector exposure? The quality exposure?

That’s what I mean when I say risk factors. The things that are going to be a driver of returns.

Levy: And so are you holding exactly the same bonds that are in the benchmark necessarily?

Barrickman: The bonds that we hold would be in the benchmark but we don’t hold all the bonds of the benchmark. So maybe an example is the best way to talk about it.

On the equity side, if you were to buy AT&T, you’ve got one ticker, and you go out and buy it on the exchange at a given price. The credit benchmark — I’m not sure what the number is; I’m just making this up — is probably about 50 or more securities.

If we go out to AT&T, we’re going to buy one of those basic securities, based on the fund’s particular need. So we might only own, let’s say, seven AT&T bonds. But we’re going to have the same weight so if AT&T makes 1% of the index, we’ll have 1% of AT&T in our fund but we’re not buying all 50 securities, we’re buying the seven securities we think we can use to replicate the entire AT&T position of the index.

Meaning that we’re going to have the same duration, same curve positioning. We’re just going to do it in this sort of sampled or optimised way so that we’re not trying to go out and buy all 50 securities.

Levy: And what is the reason to not go out and buy all the same securities? Is it just not efficient, or is there another reason?

Barrickman: It’s not efficient. It’s not feasible in most cases. So of those 50 AT&T bonds — I’m just making this up as an example — maybe 20 are liquid, and of those 20, maybe 10 are attractively priced. So we’ll go out and find those seven or 10 or whatever it is.

When you think about the equity market, you can find that one ticker. In the bond market, you’re dealing with an over-the-counter market, so you need to find the bonds, find who owns them, try and go out and negotiate a price. So it’s really just not feasible to do that for any large benchmark.

Levy: So one thing you mentioned is how it’s much more actively managed than people might think. Does this require a big team?

Barrickman: So there are 18 folks on the US team, with all different sector specialties that they look at.

Levy: And is that considered a lot of people for Vanguard or a little? How does that compare to an active manager?

Barrickman: I think, given the assets and the number of funds that we look at, it feels like a pretty lean team. We’re growing. Every year we’ve added to the headcount and probably plan to continue to do that, but we’ll just size to where we need to be to make sure we’re able to make good decisions and manage the fund as efficiently as possible.

Levy: And have you always been on the passive side? Or have you worked on the active side as well?

Barrickman: I was on the active side for three years before I came over to the passive side.

Levy: And is it difficult to make the switch over?

Barrickman: Not too much. I’ve always said, if I had to do it over, I’d do index first and then active.

I’ve always said, if I had to do it over, I’d do index first and then active.

It’s really the same concepts when you think about it. In indexing, you’re thinking about the drivers of return and the particular benchmark, and you’re positioning your portfolio to match those drivers of return.

On the active side, you’re still thinking about drivers of return, but now you’re saying, “How can I position this portfolio to have more exposure to this driver of return, because I think that is favourably priced?”

So it’s kind of similar process but in one case you’re sort of identifying and matching it, and the other case you’re having more of a view on where you think that risk factor could go and try to position your portfolio accordingly.

Levy: And why would you choose index side first?

Barrickman: I just think that being able to — we spend so much time thinking about the drivers of risk and return on the index side — I think having that thorough understanding as sort of a new trader coming into a role is an important baseline. Once you have that it’s easier to go to the next level with active. I understand how I can match them, now let me think about how I can skew my portfolio to take some bets on these risk factors.

Levy: I want to get to this bigger question in the industry with the active-versus-passive debate. From your perspective, since you’ve had experiences on both sides, what do you think the future of active management is?

Barrickman: I think there’s always a place for active management. I think it’s the great diversifier. We oversee a big index shop but we also are an active shop, and I think as long as we do it at a low cost, we do think there’s a place for it. Where you’re going to see index thrive is in the broad-based benchmarks, the traditional betas, if you will — you know, investment-grade, high-grade-type corporates and governments on the fixed-income side.

Where you’ll see people put more emphasis on the active is probably more on the less liquid parts of the market. Emerging markets, high-yield, municipals, things of that nature. I think active managers, if you’re able to pick the right active managers, you probably have potential for larger outperformance.

I think active managers, if you’re able to pick the right active managers, you probably have potential for larger outperformance.

Levy: So essentially, the more niche, harder to mimic areas of the market.

Barrickman: I think that’s right.

The case for indexing holds in every market if you just do the maths of it, but the problem has always been to identify which active managers are going to be the ones that outperform. If you think about the range of outcomes in the emerging markets versus the treasury market — you probably want to put your efforts into the market that has the broader range of outcomes and you can find the person to be able to outperform.

Levy: What are you most worried about? Anything keeping you up at night with what you see in your day to day?

Barrickman: There are a lot of things going on. We’re obviously going to stick to the benchmark day in and day out, so it doesn’t really impact us that much. I think it’s more what feels riskier. Some of the knock-on effects of the overall capital markets functioning, if you do get big political upheaval or, God forbid, some real escalation in geopolitical tensions, and things like that.

You start to worry about the knock-on effects to capital markets and how they function, and obviously, by extension, how we do our job. But I think for the most part we try to consider all the things that can happen and be as prepared as possible and manage the funds and track well, and be able to respond to all of our clients’ needs.

Levy: Do you think the risks are higher now than they were previously?

Barrickman: I don’t know. I feel like there’s more rhetoric and tweets every hour on different topics, but I don’t know if it’s just more out in front of us now than it’s ever been. I’m not sure if it’s meaningfully different than it’s been in the past.

Levy: So it sounds like these are more areas that you keep an eye on, like geopolitical risk and some political moves with the administration. But are there any areas that would affect current markets more than others?

Barrickman: I think it’s probably more around central-bank activity. Do you get some sort of policy error from the Fed or coming out of Europe that would disrupt or surprise the market?

Do you get some sort of policy error from the Fed or coming out of Europe that would disrupt or surprise the market?

You’ve got a pretty calm period in terms of credit markets and fundamentals have been fine so I’d worry more about some central-bank errors if they get it wrong and go too fast in terms of tightening conditions to where the credit market has to adjust to a new paradigm relatively quickly.

Levy: And when you say central bank, are you referring to ours?

Barrickman: Yeah, the Fed primarily. We’ve been keeping an eye on what’s happening in Europe and what’s happening in Japan and things like that.

Levy: Obviously passive has very much disrupted the active equity space. On the fixed-income side, do you think there’s risk for a lot of fund managers to be out of jobs?

Barrickman: I think we’ll continue to have adoption of passive on the fixed-income side. ETFs are a big part of that. To be able to distribute passive products. But active has a role. I think investors are comfortable on the fixed-income side, but there is room for active managers to compete and add value. And again, we’re not anti-active; we’re just anti-high-cost-active. I don’t think we’re going to see this seismic shift. We’ll probably see the creep of indexing as we go, and ETFs in particular start to see more of the investment pie.

Levy: What advice would you have for someone who’s just getting started out in their career? Say you’re 20 or 21 now, and you want to work in investment management and want to be an investor.

Barrickman: I think probably the biggest message would be you have to be really comfortable with technology. That’s where our business is going. Everyone is looking to harness the new generation of technology to figure out how to do things better and faster and more efficiently.

The folks who are going to be successful are going to have a lot of those skills and be able to really understand financial markets but, importantly, understand the interplay of financial markets and technology and how those two can be leveraged together to get superior results.

Levy: Does that apply on the index and passive side as well?

Barrickman: Yeah, absolutely. We are always looking for how technology can sort of help us do things more efficiently. We’re measuring success by tenth of basis points, and if we can figure out how to scrape those small wins by using technology or trading more efficiently through technology, we’re always going to look at it.

We’re measuring success by tenth of basis points and if we can figure out how to scrape those small wins by using technology or trading more efficiently through technology, we’re always going to look at it.

Levy: What kind of skill sets would you need?

Barrickman: You definitely need a quantitative background, have to have coding. I mean, certainly that would be a fine skill set to have, but I think just a certain understanding of how financial markets work and how technology can be in play with that. Coding would be one skill to have, but I think just that as long as you have that kind of quantitative background and then the ability to put the pieces together of markets and technology so they can come together to leverage one another.

Levy: What’s the best advice you’ve ever gotten in your career?

Barrickman: I’ve definitely had a lot of great bosses, and Vanguard is a team-oriented place. I got to work with a lot of great people. I’ve had people advocate for me and encourage me to bet on myself a little bit, take stretch assignments, and get outside the comfort zone. That’s how you grow.

I’m not sure if there’s one particular that I can point to but that’s definitely been the theme. You have to keep challenging and pushing yourself to take assignments outside your comfort zone and grow from it.

Levy: Was there any one person who told you to do that, or was it more of a collection of advice?

Barrickman: It’s kind of a collection of things. My current boss, Ken Volpert, I’ve worked for for a number of years in different capacities, and he’s definitely been a big influence and given me the opportunities to do just that. I’m very grateful for that.

With assistance from Raul Hernandez.