Maintaining ultra-short income in a late credit cycle world
Discover how a focus on proprietary credit research and active security selection can help ultra-short investors target incremental risk-adjusted returns.
J.P. Morgan’s ultra-short income ETFs help manage risk and return for investors stepping out from cash, as well as investors seeking to reduce their risk profile and move down from fixed income. As we move into the later stages of the credit cycle, we explain how a focus on active management and proprietary credit research can help ultra-short investors to target incremental risk-adjusted returns, even as markets turn more challenging.
Active security selection
We believe that ultra-short duration portfolios with a conservative, high quality allocation to credit can provide liquidity investors with incremental returns on their strategic cash balances, and fixed income investors with the opportunity to reduce credit risk and interest rate risk while maintaining an attractive yield.
However, in this late credit cycle environment, with spreads expected to widen along with an increase in credit downgrades as the cycle develops, active security selection and broad diversification across markets and sectors is essential if ultra-short investors are to maintain meaningful credit allocations and manage risk effectively. In contrast passive strategies, by design, replicate the investment universe and in doing so tend to hold large allocations of up to 40%-50% in lower-rated BBB corporates bonds given the significant weight of these securities in today’s global corporate bond markets.
Our ultra-short income ETFs are managed as part of J.P. Morgan’s $677.5 billion Global Liquidity platform (as of 30 September 2019). They benefit from the same active security selection and rigorous approach to credit risk as our money market funds. We leverage our money market fund best practice by only selecting securities from our continuously monitored approved-for-purchase list, which is maintained by our global team of more than 70 in-house credit analysts. The analysts’ ratings drive maximum tenor and concentration limits, allowing our ultra-short income ETFs to maintain a strategic exposure to credit whilst still seeking to minimise volatility throughout the market cycle.
To manage credit risk, our portfolios target the higher quality issuers. Currently, this means investing only in investment grade securities. As credit risks have risen over the last 12 months, we’ve implemented an “up-in-quality” tilt to further lift the average credit rating of our portfolios. In our JPMorgan EUR Ultra-Short Income UCITS ETF (JEST), the allocation to BBB securities has fallen from 29% in September 2018 to 15% in October 2019. A further way we apply our up in quality approach where it makes sense, is by choosing to hold certain lower rated BBB issuers we like in the shorter maturities as commercial paper holdings, in place of holding a longer dated bond out to 5 years of maturity as is permitted by the fund.
Our ultra-short income ETFs are positioned to reflect our three- to six-month strategic view of the macroeconomic outlook. As our sector allocations are driven by our medium-term fundamental cross-sector analysis, we seek to maintain portfolio diversification over the cycle. Given our approach, we do not trade in and out of sectors on a frequent basis, so turnover can be kept relatively low to reduce costs.
In many cases we look to hold securities to maturity. “‘Buy and hold” typically accounts for around two thirds of our portfolio positions. Given our active approach, however, we also seek to substitute bonds to capitalise on curve, new issue or good pricing opportunities, or equally, to access additional returns from short-term currency basis opportunities: both our euro and sterling ETFs permit an allocation to non–local currency denominated bonds, which are fully hedged back.
As securitised credit issuance is more limited in euro and sterling, cross-currency positions can also be used to enhance sector diversification. These positions can help to enhance geographical diversification compared to other ultra-short income funds, enabling us to capitalise on the global reach and deep research capabilities of the large J.P. Morgan Asset Management platform.
Capture yield and manage risk
Our ultra-short income ETFs provide a highly effective portfolio solution for cash investors looking to enhance returns on their strategic balances, or for fixed income investors looking to reduce credit risk by adding exposure to short maturity bonds.
Our ultra-short duration strategy has been running since 2004 when it was launched by the J.P. Morgan Global Liquidity group. We have recently launched our suite of ultra-short ETFs to provide an additional way for access this space, and they have proven popular with many different types of investors. The euro fund cleared the EUR 500million hurdle within the first 18 months and the US-domiciled US dollar fund is one of the fastest growing ETFs in that market, with over USD 10 billion under management (as of 3 December 2019).
Find out more about how these innovative ultra-short portfolios combine the advantages of active security selection with the liquidity, cost and transparency benefits of the ETF wrapper.