A High-Quality, Core Bond ETF Strategy | ETF Trends

When looking for a bond investment strategy, investors can consider a factor-based fixed-income ETF that could help diminish downside risks and enhance a traditional portfolio mix.

In the recent webcast, A Smarter Way for Investors to get Core Fixed Income Exposure, Samantha Azzarello, Vice President, Global Market Strategist, J.P. Morgan Asset Management, outlined the current market  environment after an extended period of growth. Economic growth remains steady, with a year-over-year change of 2.3%, the average real GDP since the financial crisis. U.S. household net worth have jumped to $114 trillion from $71 trillion back in 2007, with debt service ratios decreasing over the past decade. Federal Reserve policies also remain accommodative as the U.S. faces slowing growth and stubbornly low inflation rates.

In this type of lower-for-longer yield environment with steady growth, fixed-income investors have taken a greater interest in the relatively more attractive yields in corporate debt. Meanwhile, the percentage of Baa-rated investment-grade corporate debt outstanding has increased to 50%, and duration of the investment-grade corporate credit universe has risen to 7.8 years, compared to an average of 6.2 years. Investors are essentially faced with a growing portion of lower rated investment-grade debt and rising exposure to interest rate risks.

The search for yields is still an ongoing issue as negative yielding debt around the world has surged to $17 trillion earlier this year. However, investors are faced with increased risks if turning to higher-yielding options. For instance, corporate fundamentals have deteriorated. Over the past 15 years, leverage has more than doubled and interest cover has rapidly declined.

“This deterioration could result in heightened volatility and rolling downgrades, which would negatively impact investment grade indices,” Josh Rogers, Investment Specialist, Beta Strategies, J.P. Morgan Asset Management, said.

Investors, though, can still gain exposure to this segment and limit risks through specialized strategies. For example, the factor-based JP Morgan US Aggregate Bond ETF (NYSEArca: JAGG) holds a diversified portfolio of high-quality fixed income securities, including corporate bonds, U.S. Treasuries and government, and agency securities. Unlike the traditional market cap-weighted bond index funds, the ETF applies a multi-factor credit screening process that seeks exposure to corporate debt issuers with attractive value, quality and momentum characteristics.

Rogers explained that the three key characteristics, which determine the most sound issuers to own within the universe, cover companies that are undervalued compared to their fundamental quality; companies with strong profitability, low leverage, and high interest coverage; and companies with positive recent performance in both credit and equity markets

“Using a combined view of these characteristics can lead to lower risk, higher returns, and also helps mitigate unnecessary turnover,” Rogers said.

Consequently, the indexing methodology incorporates fundamental insights that may help JAGG outperform during stressed equity environments while offering compelling value proposition at a competitive cost with debt weighted counterparts.

Financial advisors who are interested in learning about the fixed-income strategy can watch the webcast here on demand.