J.P. Morgan ultra-short income ETFs

How can investors seek to reduce portfolio drawdowns while staying invested and aiming to outperform cash? We think active ultra-short fixed income could have a role to play.

It’s understandable that investors may not have given this part of the fixed income spectrum much consideration over the last 15 years. For most of that period, low interest rates meant the returns on offer from ultra-short fixed income investments weren’t particularly appealing. However, in the last couple of years, higher interest rates have led to a more attractive return profile and we don’t expect interest rates to return to their prior lows, even in a recession.

The very short duration of ultra-short fixed income, which we define as having a portfolio duration of up to a maximum of one year, helps to limit the volatility from moves in market interest rate expectations.

We believe many investors are looking for part of their portfolio to deliver returns with low volatility while still aiming to outperform cash. They may be looking to offset some of the volatility coming from the equity part of a portfolio. They may also be keen to protect against the significant drawdowns that can be experienced in fixed income exposures with higher duration or higher credit risk. For anyone looking for a defensive portfolio allocation, the low historical drawdowns associated with ultra-short fixed income could be of interest.

Investors don’t need to think too far back to be reminded that longer-duration fixed income doesn’t always provide the portfolio protection they may be looking for. Longer-dated government bonds could perform well in a recession if interest rates end up being cut by more than is currently priced in.

However, they could also be vulnerable to higher-than expected inflation or economic growth, which could cause rates to be cut less quickly than expected.

Ultra-short fixed income isn’t reliant on getting big macro calls on growth and inflation correct to deliver returns with low volatility. That said, actively managing credit risk and the ability to actively extend duration up to a maximum of one year, when short-term rates are expected to fall, can help with the goal of outperforming cash, while still maintaining a low volatility.

Longer-dated fixed income and equities can potentially deliver higher returns—but they can also result in larger losses in certain scenarios. Ultra-short fixed income can play a useful tactical or structural defensive role in portfolios alongside these other investments.