Hitting the sweet spot between liquidity and short duration
Thanks to its ability to invest actively across a diversified basket of high quality, very short maturity bonds —including a conservative allocation to credit—our EUR Ultra-Short Income ETF (JEST) can help cash investors earn incremental returns on their strategic balances, while also providing fixed income investors with the opportunity to reduce interest rate risk, manage credit exposure and target a zero-to-positive return over time.
Complement your core
In the current deeply negative market environment, ultra-short duration, hybrid-type cash strategies can provide a vital “core complement” to any diversified liquidity or fixed income portfolio, reducing the negative yield drag and managing duration risk while also maintaining access to high levels of liquidity.
However, with credit risk dispersion elevated in today’s markets, it’s crucial for investors to seek out strategies that are backed by proven in-house credit research capabilities. As the Covid-19 outbreak highlighted, when it comes to ultra-short duration strategies that can produce consistent cash-plus returns across the credit and interest rate cycle, security selection is key. At the height of the crisis, some ultra-short funds with less rigorous credit allocations came under pressure and struggled to provide liquidity when investors needed it most.
By contrast, our JPM EUR Ultra-Short Income UCITS ETF (JEST), remained liquid through the market turmoil. Thanks to our conservative approach to credit risk and our focus on high quality security selection, JEST was able to satisfy all redemptions in cash, not in-kind, while maintaining an attractive cash-plus yield.
Active credit risk
The secret to JEST’s success is its active security selection, backed by the rigorous proprietary credit research and conservative philosophy of our Global Liquidity platform—including access to the team’s approved for purchase list. It’s this cautious approach to risk, combined with active credit management, which helped JEST provide the liquidity and lower volatility investors required even as liquidity dried up and credit spreads widened dramatically in the early stages of the Covid-19 outbreak.
Our active security selection meant that we were able to respond quickly to deteriorating market signals at the beginning of the year by reducing exposure to lower-rated BBB credits, selling securitised credit holdings and reducing exposure to riskier floating rate notes before they came under pressure. Crucially, our credit research meant JEST was able to remove exposure to specific issuers that we deemed particularly risky, while our strategy holds mainly fixed cash bonds to boost stability.
The fund’s credit risk is also globally diversified. JEST is more geographically diversified than many of its peers, providing better diversification of holdings and access to basis returns, as well as cross-currency opportunities.
Liquidity ladder
While conservative and diversified credit management provides JEST with a solid foundation that investors can trust to reduce volatility through the market’s ups and downs, our focus on liquidity—backed by the experience of our Global Liquidity Platform—really sets the fund apart. To manage liquidity risk at the peak of the market stress, we built a pronounced liquidity ladder by significantly increasing exposure to a blend of short-term bonds (with less than three-month maturities) and money market securities.
We also only hold cash bonds, with derivatives limited to cross-currency positioning. The fund’s only derivative exposure is to currency forwards. It’s this relentless focus on liquidity management that has ensured that the fund has been able to manage heightened investor activity throughout the Covid crisis, with all redemptions satisfied in cash.
Careful risk deployment
We’re confident that our conservative approach can provide a safe haven in a crisis. However, JEST is also nimble enough to add risk carefully when market conditions improve.
As sentiment picked up following the Covid crisis, and short-term bond markets and credit spreads rebounded in response to unprecedented global policy support, we positioned the fund to generate returns by carefully deploying risk in certain well-priced corporate and asset backed securities—an approach that allowed JEST to take full advantage of the sharp rally in spreads through the spring and summer.
The fund was also able to generate returns from tactical exposure to the stronger recovery in the US market, which was boosted by the early implementation of numerous liquidity facilities by the Federal Reserve. The fund can access US opportunities by buying dollar-denominated short-term bonds and money market instruments, and then fully hedging them back to euros.
We take a conservative approach to managing corporate credit
Caution ahead
While we’ve been adding some risk to the portfolio in selected areas, we retain a cautious stance and are ready to manage other potential spikes in volatility that lie ahead, such as the US presidential election in November and Brexit at the end of the year.
Our main focus is on what kind of recovery we can expect into 2021. Although the range of central bank liquidity facilities that are now in place, as well as renewed quantitative easing, should help manage volatility, there could still be additional risk-off periods ahead—particularly with Covid infections picking up again—while investors could be spooked by rising downgrades and defaults.
At the same time, spreads have tightened significantly since the height of the crisis, which means compensation for the risk taken in credit markets is lower. We have therefore continued to rigorously scrub our corporate holdings daily to ensure our team of 70+ credit analysts are supportive of all the exposures we hold. We believe our proprietary credit research is key to helping the fund sidestep the increase in downgrades that lie ahead.
We also want to ensure that, in the event of a repeat period of market stress, we have a natural ladder of liquidity to enable us to satisfy any possible outflows. We therefore maintain our ladder in positioning and have been selectively adding returns via cross-currency and some securitised positions.
Cash-plus returns and a low risk approach
JEST aims to outperform money market fund returns by 40-60 basis points over the cycle, while deploying the least amount of risk as possible*. The fund is more credit conservative than many peers, but is dynamic in its risk management, allowing it to leverage our global fundamental research platform in the search for returns—a crucial factor in a negative yield world where every basis point counts.
Together with our retention of a liquidity ladder, we believe our cautious risk deployment will help JEST manage through the bumps in volatility that may lie ahead, supporting our goal of limited volatility and cash-plus returns in these challenging markets.
*These targets are the investment manager’s internal guidelines only to achieve the fund’s investment objectives and policies as stated in the prospectus. The targets are gross of fees and subject to change. There is no guarantee that these targets will be met.
