2023-09-21 11:15:08 ET
Summary
- JPMorgan Ultra-Short Income ETF is a fixed income ETF with low volatility and attractive risk analytics.
- However, JPST fails to compete with other corporate bond funds in terms of compensating investors for credit risk.
- Furthermore, the short end of the Treasury curve now yields more than JPST, with outright Treasuries or funds like SGOV providing for higher 30-day SEC yields.
- Retail investors need to ensure they get compensated for corporate risk in today's rates environment where short term risk-free yields are extremely compelling.
Thesis
JPMorgan Ultra-Short Income ETF (JPST) is a fixed income exchange-traded fund. We have covered this name before, back in 2022, when we assigned a Buy rating:
Prior Rating (Seeking Alpha)
The fund has had a positive total return since, with a very low volatility profile as per the risk metrics produced by Seeking Alpha:
Analytics (Seeking Alpha)
We can see a sub 1 standard deviation and an annualized volatility of 0.62%. That translates into a retail investor expecting a maximum drawdown of -1% here. This fund is a cash parking vehicle, and its analytics fully reflect that.
However, this fund is a corporate bond fund. The vehicle contains corporate risk via bonds and commercial paper, and thus should compensate investors for that risk, irrespective of how reduced it is. Unfortunately, JPST fails to compete on this front:
Analytics (Author)
We are comparing the fund here with the PIMCO Enhanced Short Maturity Active ETF (MINT), with the iShares 0-3 Month Treasury Bond ETF (SGOV) and the SPDR Bloomberg 1-3 Month T-Bill ETF ( BIL ).
While JPST and MINT do have default risk via their collateral, SGOV and BIL do not since they are entirely composed of treasuries. JPST has an exclusively investment-grade collateral, but a retail investor needs to understand they are due fair compensation for any credit risk taken:
Ratings Matrix (Fund Fact Sheet)
As a reminder, all of the regional banks that went into receivership in March had been rated investment-grade . 17.9% of the collateral is rated BBB here, and 19.4% of the holdings are single-A. To note for a retail investor that the 'A-2' and 'A-3' ratings above which might look out of place actually denote commercial paper issuances:
Commercial paper consists of short-term, promissory notes issued primarily by corporations. Maturities range up to 270 days but average about 30 days. Many companies use CP to raise cash needed for current transactions, and many find it to be a lower-cost alternative to bank loans.
Source: The Fed
The A-1, A-2 and A-3 ratings come from S&P, and they denote good quality commercial paper issuances.
As of now, JPST via its 30-day SEC yield delivers a yield inferior to MINT, and a yield that is only 0.04% higher than the one SGOV provides. In our mind, irrespective of the rating profile, a corporate bond fund cannot compensate investors for credit risk via a spread of 0.04%. As a rule of thumb, we would use 25 bps (or 0.25%) as a threshold. A well-diversified and granular short-dated fund would be able to absorb 1 or 2 defaults in a black swan scenario via that type of margin. It is not the case here.
The front end of the yield curve looks attractive
Moreover, the front end of the yield curve currently looks extremely attractive, with yields in excess of 5.4%:
Yield Curve (Investing.com)
A retail investor can go to their online brokerage platform and buy 6 months Treasury bills that will yield 5.56%, which is in excess of the 30-day SEC yield provided by JPST, with treasuries not having any default risk.
A nice feature about purchasing treasury bills outright is the fact that they are a discount instrument, meaning an investor will not have to wait for a monthly payment, but the instrument will deliver daily value accruals via its price. The T-Bill 'pulls to par' on a daily basis (absent significant market interest rate changes) and thus will accrete a nice positive every day and week.
Performance
The fund has underperformed both its pure treasury and its corporate bond peers:
While the underperformance is small, it nonetheless speaks to the fund's capabilities, and in the short-dated fund space 20-30 bps do matter.
JPST is not going to generate negative returns or experience significant drawdowns. However, on a relative basis, the fund does not look attractive in comparison with its peer group or outright treasury holdings.
Fund holdings
The vehicle holds a mix of corporate bonds, commercial paper and asset backed securities:
Sectoral Allocation (Fund Fact Sheet)
The highest weighting is with corporate bonds at 39.8%, followed by CP at 27.4%. To note that CP also represents corporate exposure, since it purely represents a short-dated funding instrument for said corporations.
The fund has a balanced rating approach:
Ratings (Fund Fact Sheet)
It is good to see the vehicle not being overly aggressive on the BBB bucket (the riskiest investment-grade slice), but at the same time, higher ratings translate into a reduction of the yield paid out to investors.
As per its duration profile, the fund is short-dated, however, there are a number of bonds with maturity dates higher than 1 year:
Maturity Ladder (Fund Fact Sheet)
We can see from the above table that 23.2% of the collateral pool has a maturity date that exceeds 12 months.
How to think about short-dated bond funds
Well-constructed short-dated bond funds act like cash parking vehicles that give retail investors a spread over risk-free instruments. If we look at the ICE BofA Single-A US Corporate Index Option-Adjusted Spread, we can see it is trading at 104 bps over risk-free rates:
Admittedly, the duration is longer here, but the index should give retail investors a flavor where AA investment-grade risk trades against a risk-free curve. Even for very short duration bond funds like JPST, although there is virtually no duration component, there is however a default probability risk.
By definition, a corporate bond fund like JPST should not trade at a yield below similar duration treasuries because JPST has credit default risk, whereas treasuries do not.
Conclusion
JPST is a fixed income exchange-traded fund. The vehicle falls in the short-term cash parking vehicles category, but it fails to deliver when it comes down to yield. With an average single-A collateral profile and a 0.6-year duration, the fund only yields 5.38% on a 30-day SEC yield basis.
JPST trails not only other short-dated corporate bond funds like MINT, but also outright 6 months treasuries, which now yield 5.56%. No matter how small, corporate risk needs to be compensated for with a spread over risk-free rates, and JPST fails to do that at the moment.
There is nothing wrong with JPST outside its uncompelling 30-day SEC yield. It has had a nice upward sloping total return profile with very low risk analytics. It will continue to make money. However, the question is whether retail investors are correctly compensated for the corporate risk taken and whether the market presents better alternatives. Our view is that a retail investor would only act rationally to go for a higher yield in an instrument that has no credit risk, such as SGOV or an outright treasury at this stage. We are therefore downgrading JPST to Hold.
For further details see:
JPST: Short-Dated Bond Fund That Fails To Compete (Rating Downgrade)