Ultra-short income ETFs: Active portfolio construction to optimise credit and liquidity risk
We believe our Ultra-Short Income ETFs are an ideal way to maximise yield while minimizing risk. Our active management approach combines a top-down macroeconomic view and investment strategy framework with a granular bottom-up research platform specialised across fixed income sectors. The result is a portfolio that constantly seeks to optimise risk and reward as market environments change. As an active ETF, this same active strategy that we have been managing for 15 years can be used by more clients and with more flexibility – without sacrificing any of its liquidity or quality characteristics.
Managing credit risk from the bottom up
In order to achieve a higher yield than traditional money market funds, ultra-short duration strategies invest in a more diverse basket of securities to carefully add risk – so managing credit risk is a critical part of our process. Our Ultra-Short Income ETFs leverage the credit capabilities of our full investment grade team of over 70 credit analysts, specialised by industry and sector, and spread around the world; this gives our portfolio managers greater insight into the companies we are buying. The analysts assign their own internal rating to each individual issuer, an important input into portfolio construction decisions.
The Global Liquidity team then uses the “credit matrix” – its conservative framework to managing credit risk. The internal rating determines whether the security is approved for purchase for our ETFs, while the credit matrix assigns a maximum tenor and a maximum position size per issuer. While the maximum portfolio duration permitted is one year, the maximum final maturity for each individual security in the Ultra-Short Income ETFs is five years. In line with the credit matrix approach, for securities with lower internal ratings, we typically hold smaller position sizes that are laddered (evenly spaced) across maturities.
The credit analysts and portfolio managers continually monitor these limits and the credit ratings. Our monthly governance meetings tap the additional insights of our distribution, risk, legal and compliance teams.
Tactically positioning from the top down
At the same time as our bottom-up process identifies the most appropriate securities for our Ultra-Short Income ETFs, our portfolio managers are forming an investment strategy based on key market themes, which help form positioning on, for example, duration, spread duration and sector allocation.
Senior investment professionals from our ultra-short duration strategy team meet monthly to discuss our fundamental outlook for the economy – focusing on factors such as GDP growth, unemployment and interest rates – and identify key investment themes that guide portfolio decisions. The portfolio management team then uses scenario analysis to evaluate security and portfolio performance in different environments to help determine optimal positioning on the yield curve and across sectors.
This top-down element to our portfolio construction process can be particularly valuable to ensure appropriate levels of risk and liquidity in rapidly changing market environments.
Active portfolio construction in action
Our actions in early 2020 show just how active we can be to manage volatility and liquidity. We trimmed risk early as we saw Covid-19 concerns building in February 2020: we reduced BBB rated securities and securitised credit, and also sold floating-rate notes and certain sector positions, such as energy-related securities. We anticipated increased activity and clients calling on their cash; accordingly we tried to minimise risks through careful management of maturities, that is, by increasing our liquidity ladder, building up around 30% in sub one-month liquidity through the crisis months.
Our internal credit team was an invaluable resource and we worked closely with them to critically review all corporates on our approve-to-purchase list, in light of the new and more challenging market environment, which saw the sectors that many of these corporates operate in, totally locked down. As a result of our analysis we were able to manage risk appropriately and meet all redemptions over the crisis in cash, rather than in-kind.
Keeping a close eye on credit, we tactically added back risk over the second and third quarters of 2020 at attractive levels, while still retaining the liquidity ladder. We have continued to hold some of this natural liquidity despite markets normalising . Carrying this dry powder ensures that we are ready to purchase attractive new issues and add cross-currency positions, where we have the opportunity to generate additional returns through currency basis.
As an active manager, we have the flexibility to buy the securities we want, when we want and are not forced to hold benchmark positions that could bring unwanted risk or a drag on performance.
Same ultra-short strategy in an active ETF
All the benefits of our USD 98 billion active ultra-short duration strategy – from the top-down investment views to the bottom-up security selection – go into our Ultra-Short Income ETFs. Our ETFs also benefit from our entire Global Liquidity platform’s access to the underlying liquidity in the market, which is particularly important for a liquidity ETF. Lastly, the ETF wrapper itself adds an additional layer of liquidity as an easily traded investment vehicle that is available to many types of investors.