Sustainable, Responsible &/or ESG Policy:

The Fund promotes environmental and social characteristics by excluding companies from its portfolio based on the impact of their conduct or products on society and / or the environment. This is met by tracking the Index. The Index excludes stocks of companies that the sponsor of the Index determines to be engaged or involved in, and / or derive revenue (above a threshold specified by the Index provider) from, the following activities: (a) Vice Products (i.e., adult entertainment, alcohol, gambling, tobacco, cannabis); (b) Non-Renewable Energy (i.e., nuclear power, fossil fuels (including power generation from oil, gas, and thermal coal)); and (c) Weapons (chemical & biological weapons, cluster munitions, antipersonnel landmines, nuclear weapons, civilian firearms, and conventional military weapons). The index methodology also excludes companies that, as determined by the Index provider, are involved in severe controversies (i.e., companies which do not meet the labour, human rights, environmental, and anticorruption standards as defined by the United Nations Global Compact Principles).

Process:

All of Vanguard’s equity ESG index funds and ETFs use the FTSE Global Choice Index Series which is transparent, simple to understand and is closely aligned to Vanguard’s approach to exclusionary index investing. The investment approach for our equity ESG funds is based on the below exclusion process:

• FTSE – identifies the securities for exclusion and provides the screened benchmark.
• Vanguard – tracks the screened benchmark.
• Investor – gains broad market exposure with ESG exclusions.

The Vanguard ESG Developed World All Cap Equity Index Fund tracks the FTSE Developed All Cap Choice Index. The index is constructed from the FTSE Developed All Cap Index (the Developed Parent Index) which is then screened for certain environmental, social and corporate governance criteria by FTSE.

 Vanguard equity 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 Equity Index Group (EIG) uses third-party order management software provided by Charles River Development, which combines portfolio management, trading, compliance, risk management and operations capabilities to allow efficient straight-through transaction processing.

EIG’s process initiates after the nightly batch cycles complete, which includes portfolio risk monitoring (post-trade compliance).

Start-of-day controls

The following controls are performed by our portfolio managers:

• Investment tolerances: Start of day and end of day review of several investment tolerances including tracking error and liquidity, as well as sector and issuer active weights.
• Cash flow projection: Daily review of the portfolio’s net cash flow (e.g. client subscriptions and redemptions as well as dividends).
• Index activity: Regular review of index provider updates, including information about corporate actions and rebalancing. Portfolio managers also provide additional oversight of the controls that are performed periodically by Global Investment Data Management (GIDM), which ensure that index data in our portfolio management system matches that of the provider’s published index.
• Guidelines: Daily review of start of day and end of day deviation metrics, which compare portfolio positions (by security) with index weights to ensure portfolios remain in line with their respective index; only very small deviations may be permitted, to ensure minimal tracking error.

Portfolio review and construction

Vanguard’s portfolio managers begin their day reviewing the abovementioned metrics to confirm start-of-day positions are in line. Portfolios must be adjusted for cash impacts related to index changes and corporate actions. Intraday cash flows are systematically fed into our proprietary portfolio management tool and cash is invested in line with the benchmark using a combination of equities, futures or a combination of both. Finally, the portfolio managers must rebalance each fund on a quarterly basis due to index rebalances.

EIG uses a third-party optimisation tool, Axioma, to support portfolio construction for optimised strategies. Characteristics and fundamental factors, such as industry, currency, country, size, price-to-earnings ratio, yield, debt-to-assets ratio and beta are considered in the optimisation process. Trade list generation and fund cash flows are managed using these tools.

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. Our Investment Risk Management group 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 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.

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.

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 overcollateralisation increases for non-Treasury securities. Vanguard’s fund accounting department maintains the collateral, with market prices used to value the securities.

Index selection

When Vanguard assesses which index to track, we look at our best practices for index construction. Without liquidity, or the ability to be replicated, an index would fail to be trackable and would fail to meet our requirements and our investors’ needs.

We rigorously monitor our portfolios by evaluating our fund holdings, our turnover versus the assets we hold and by looking at liquidity thresholds. We stress test our portfolios regularly and these simulations allow us to understand whether we would be affected by situations such as those that arose in 2008 (Lehman's collapse), 1994 (when US rates rose aggressively) and 1987 (when the stock market crashed). There have been no negative findings from these stress tests to date and we will continue this rigorous approach to testing.

It is important to note that liquidity will always vary across time and market and we try to avoid trading during illiquid times. We follow broad based, diversified benchmarks that exclude some of the most illiquid securities.

To further help our funds’ liquidity, we may opt to use an optimised/sampling replication method if there are securities in the underlying index which we feel may diminish the funds’ liquidity profile.

Rebalancing considerations

Through the variety of indices that Vanguard portfolios track and our longstanding experience with equity index providers (e.g. CRSP FTSE, MSCI, S&P, Russell and Wilshire), we have acquired expertise in managing index changes in various equity market segments (global, large-cap, mid-cap and small-cap securities) and market conditions. Constituents of an index and their relative weightings can change over time. When these changes occur, we will review and take action as appropriate for each portfolio on a case by case basis.

We pay very close attention to these changes and how they affect individual security price movement. We have implemented robust procedures to monitor announcements made by the index providers regarding index changes.

The index portfolio management team analyses index changes. Our portfolio managers are also traders, allowing for effective implementation of any changes. Based on our analysis of the potential market impact cost vs. tracking risk of every index change, Vanguard may decide it is more prudent to execute some trades at prices other than the closing price of the index change.

The execution of trading strategies to implement index changes is dependent on the type of change that is taking place. While the bulk of trades are typically conducted at the market close, we recognise these trades can be “costly” and that many clients can tolerate a limited amount of tracking error in order to reduce execution costs. Vanguard regularly executes alternative trading strategies designed to balance clients’ objectives of minimising both potential tracking error and trade execution costs.

Vanguard equity index portfolios are managed using a daily process. Each portfolio is monitored and rebalanced (if needed) every business day to ensure close tracking to its benchmark index. We typically use index futures contracts to reinvest dividend income or reclaimed tax (if appropriate) in our equity index portfolios. Using index futures contracts works particularly well in this scenario, allowing dividend receivables to be invested until the dividend payment date so that the fund follows the index methodology, limiting tracking error.

Resources, Affiliations & Corporate Strategies:

There are close to 100 employees who consider ESG as part of their responsibilities. This includes employees in Investment Stewardship who consider ESG issues as part of their daily responsibilities, as well as employees who consider ESG issues as part of their broader role.

Our credit analysts develop independent risk assessments and investment opinions for each fixed income issuer. They seek to understand the investment implications of ESG risks and determine whether market pricing adequately reflects these risks.

Similarly, investment stewardship sector analysts use ESG data and research to inform our active ownership practices, including engagement. In our engagements, we advocate for effective oversight of ESG practices that consistently support the creation of long-term value for investors.

Representatives from all these groups also sit on our cross-divisional responsible investment team. In recent years, additional staff members were hired to support our approach to analysing ESG risks in our funds.

The Fixed Income Group (FIG) credit research analysts make use of both internal and external sources for ESG information.
Internal resources

For our active fixed income assets, 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

These resources are inputs to independent analyses conducted by our team of credit research analysts, which are tailored to each investment opportunity. Our approach carefully considers the investment implications of ESG risk factors along with other risk factors to ensure thorough due diligence is done both prior to initial investment and on an ongoing basis. FIG incorporates the views of our credit analysts within the issuer selection process.

In addition, credit analysts in FIG use an ESG risk assessment process to flag issuers with material ESG risks. Analysts are responsible for identifying, recording, and monitoring the issuer’s ESG risk and progress toward addressing related issues. This process is overseen by our ESG committee, composed of six members of the global fixed income credit research team. This committee complements our investment decision-making process, including the assessment of ESG risks among other risk assessments conducted by our team of fixed income analysts. The committee is responsible for evaluating external ESG data and research resources used in our investment processes. Team members are also responsible for the continuous improvement in the integration of ESG concepts and department operating procedures.

External resources

Our dedicated research team will use information provided by various sources, including the rating agencies (i.e. Moody’s & S&P), Bloomberg, Sustainalytics sell-side research, and issuers. These resources are inputs to independent analyses conducted by our team of credit research analysts, which are tailored to each investment opportunity. Our approach carefully considers the investment implications of ESG risk factors along with other risk factors to ensure thorough due diligence is done both prior to initial investment and on an ongoing basis.

Participation in industry initiatives

Vanguard is involved in the following initiatives (year in brackets denotes when we joined or became a signatory):

• Commonsense Corporate Governance Principles (2016)   
  Vanguard is a founding member of this initiative. Former Vanguard CEO, Bill McNabb, participated in preparing the Commonsense Principles of Corporate Governance position paper.
• Sustainability Accounting Standards Board (2016)   
  Vanguard serves on The Investor Advisory Group.
• Investor Stewardship Group (2017)   
  Vanguard is a founding member. We actively promote the framework and engage with companies on its substance.
• 30% Club (2017)
  In May 2017, Vanguard joined the 30% Club, a global organisation that advocates for greater representation of women in boardrooms and leadership roles.
• Principles for Responsible Investment (2014)
  Vanguard is a signatory and fully committed to the adoption of the principles.
• International Corporate Governance Network (ICGN) (2019)
  ICGN is an investor-led organisation with a mission to promote effective standards of corporate governance and investor stewardship to advance efficient markets and sustainable economies worldwide.
• CDP Global (2018)
  CDP Climate Change, signatory
  CDP Forests, signatory
  CDP Water, signatory
• Council of Institutional Investors (CII) (2017)
  CII is a non-profit, non-partisan association of corporate, public and union employee benefit funds and endowments with a focused policy mission: to be the leading voice for effective corporate governance practices for US companies and strong shareowner rights and protections.
• CECP (CEO Force for Good) Strategic Investor Initiative
  Co-chaired by Vanguard's former CEO, Bill McNabb, it encourages companies to share their long-term strategic stories and focus more of their disclosure and reporting on sustainable long-term value creation.
• Embankment Project for Inclusive Capitalism (EPIC) sponsored by the Coalition for Inclusive Capitalism (2018)
  EPIC was an 18-month long collaborative initiative which brought together professionals from 31 companies, asset managers and asset owners, who worked together to identify and create new metrics in order to demonstrate and measure long-term value in financial markets. Vanguard served as chair of the Existing Initiatives working group.
• Business Roundtable’s Statement on the Purpose of a Corporation (2019)
  Vanguard is a signatory.
• Energy Transition and Care for Our Common Home participant statement (2019)
  The Vatican’s participant statement on climate risk disclosures calls on companies to be transparent about climate-related matters and disclose them to investors. Vanguard is a signatory.
• Net Zero Asset Managers initiative (NZAM) (2021)
  Founded in December 2020, the Net Zero Asset Managers initiative is a group of global asset managers committed to supporting the goal of net zero greenhouse gas emissions, in line with global efforts to limit global warming to 1.5 degrees Celsius and to support investing aligned with net zero emissions, both by 2050 or sooner.

Vanguard is also supportive of local governance or stewardship codes, such as:

• The UK Stewardship Code
• Hong Kong Principles for Responsible Ownership
• Japan’s Corporate Governance Code
   

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Dialshifter

This fund is helping to ‘shift the dial from brown to green’ by…

The ESG Developed All Cap product is an exclusionary product which is screened for certain environmental, social, and corporate governance criteria. The fund does not have a climate objective, but do exclude companies within the non-renewable sector. Separately, our Investment Stewardship will vote, engage and advocate with the companies in the investment universe on behalf of the shareholders on ESG matters.

Our organisation is helping to support the Paris Climate Agreement and the Race to Net Zero by…

Please refer to our website:

https://corporate.vanguard.com/content/corporatesite/us/en/corp/who-we-are/we-care-about/sustainability.html

SDR Labelling: Not eligible to use label