Passive fixed income investing alone can’t create the stability, diversification, and return potential that investors expect from their bonds, leaving them vulnerable to the changing investment characteristics of fixed income indexes. Alternatively, investors can turn to active bond exchange traded fund strategies to better navigate the changing markets ahead.
In the recent webcast, Solving the Bond Problem: Active Fixed Income, J.P. Morgan Asset Management’s Benjamin Christensen, managing director and investment specialist of Global Fixed Income Currency & Commodities, pointed out that passive index-based bond funds that track benchmarks like the Bloomberg U.S. Aggregate Bond Index are not sufficiently accessing the overall fixed income markets. The CRSP U.S. Total Market Index can help investors access 96% of the total U.S. equity markets, but the so-called Agg only provides exposure to 52% of the total U.S. bond market.
Christensen also noted that these market capitalization-weighted fixed income indexes, like the Agg, are actually rewarding the most indebted borrowers. In other words, the most indebted issuers with the highest value of outstanding debt would have a higher market capitalization in a fixed income cap-weighted bond index.
Looking ahead, Christensen explained how a potential taper should cause the Agg’s allocation of US debt to grow since the private market will hold a greater percentage of US Treasuries, and that will be reflected in the Agg index holdings.
Meanwhile, bond investors who have relied on the Agg are exposed to increased risks with smaller rewards to show for it. In 1989, the Agg had a 4.5-year duration and a 9.1% yield, but the Agg now has a 6.3-year duration and a 1.5% yield. In other words, the Agg is exposed to greater rate risks and offers a lower yield to investors today.
Alternatively, Christensen pointed out the long-term outperformance of the actively managed Morningstar Intermediate Core Plus Bond universe, which could offer investors another way to access the fixed income markets. The Core Plus Universe has historically outperformed the passive Bloomberg Capital US Aggregate Bond Index 97% of the time.
Cary Fitzgerald, managing director and portfolio manager, also noted that a short-duration core plus could maximize risk-adjusted returns through a diversified multi-sector approach while keeping interest rate risk low.
“We manage both interest rate risk as well as credit spread risk. Not only is the overall duration of the fund shorter than traditional ‘Aggregate’ bond strategies, we are focused on the front end of the yield curve, which is more heavily controlled by the Fed Funds policy rate. Shorter corporate bonds exhibit significantly less price volatility than longer corporates,” Fitzgerald said.
“Our results have been exceptional with not only top decile absolute returns, but also very strong risk-adjusted returns, particularly during periods of volatility like March 2020 and Q4 2018,” Fitzgerald added.
Looking at the actively managed strategy since 2020, Fitzgerald explained that in March of last year, the first important risk management decision they made was to cut credit risk before March because spreads were tight, which helped protect from greater losses and created the dry powder to take advantage of poor liquidity and cheap bond offerings. During March to early April, they sold 15% of Treasuries in favor of IG corporates at very attractive levels, which set us them up for very strong returns over the next couple of quarters. In Q4, J.P. Morgan started taking profits on these IG corporate adds and began investing more heavily into HY, which has much greater potential given their fundamental outlook.
As a way to access J.P. Morgan’s actively managed style, investors can turn to something like the JPMorgan Core Plus Bond ETF (JCPB), which tries to generate a high level of income by investing in high-, medium-, and low-grade debt securities.
The ETF will include exposure to corporate bonds, U.S. treasury obligations, other U.S. government and agency securities, and asset-backed, mortgage-related, and mortgage-backed securities. JPCB may invest in debt securities rated below investment-grade (i.e., high-yield or junk bonds) or the unrated equivalent, including those from foreign and emerging markets.
Under normal conditions, the ETF will hold 65% of its portfolio in investment-grade securities, and will not hold more than 35% of assets in below investment-grade or speculative-grade securities. Furthermore, up to 35% of the fund’s portfolio may be invested in foreign securities, including securities denominated in foreign currencies.
Additionally, the JPMorgan Short Duration Core Plus ETF (JSCP) is an actively managed fixed income ETF designed to deliver total return consistent with the preservation of capital by investing in investment-grade and non investment-grade short-term fixed income securities.
JSCP employs a multi-sector approach to create a diversified portfolio while managing risk. Seeking to maintain a duration of three years or less, the fund offers the flexibility to allocate assets to below investment-grade securities and international debt to seek additional yield.
Financial advisors who are interested in learning more about this active fixed income strategy can watch the webcast here on demand.