2024-01-06 00:09:01 ET
Summary
- Short-term yield funds like the JPST ETF are marketed as cash replacement tools.
- The JPST ETF underperformed money market funds in 2023 due to rising interest rates.
- However, with policy rates on hold and potentially declining in 2024, JPST should return to outperforming money market funds in the coming quarters.
Last year, when I reviewed the JPMorgan Ultra-Short Income ETF ( JPST ), I noted that the JPST ETF was a viable cash replacement tool. However, unlike true cash instruments like money market funds, the JPST ETF does have modest amounts of duration and credit risk in its portfolio, as it held short-term corporate bonds and commercial paper.
As the Federal Reserve was in the midst of an interest rate hiking cycle, the JPST ETF, with its 0.27 year duration, underperformed money market funds like the iShares 0-3 Month Treasury Bond ETF ( SGOV ), returning 5.1% compared to 5.5% for SGOV (Figure 1).
Figure 1 - JPST underperformed money market funds (Seeking Alpha)
As we begin 2024, should investors continue to stick with money market funds or consider switching into cash replacement funds like JPST for their cash allocations?
Brief Fund Overview
The JPMorgan Ultra-Short Income ETF uses short-term investment-grade ("IG") fixed- and floating-rate securities to generate high current income for investors. JPST targets a duration of less than 1 year and is marketed as a cash replacement tool for investors.
JPST's portfolio primarily consists of IG corporate bonds (44.2%), commercial paper ("CP", 18.9%), certificate of deposits ("CD") and asset backed securities ("ABS") (Figure 2).
Figure 2 - JPST portfolio allocations (am.jpmorgan.com)
JPST's portfolio holdings are all highly rated, with the lowest credit rating being a 20.0% allocation to BBB-rated IG securities. 72.4% of the portfolio has a maturity of less than 1 year, while 26.3% has maturity between 1-3 years. JPST has a portfolio duration of 0.54 years as of November 30, 2023.
Comparing JPST's portfolio between November 30, 2023 and my last article, we can see an increase in JPST's portfolio duration, from 0.27 years previously to 0.54 years currently (Figure 3).
Figure 3 - JPST portfolio duration was 0.27 years in early 2023 (am.jpmorgan.com)
Comparing asset allocations, JPST has increased its allocation to IG corporate bonds from 37.3% to 44.2%, while CP has been reduced from 22.9% to 18.9%. BBB-rated securities have increased from 15.0% to 20.0%, while AAA-rated has been reduced from 20.2% to 17.4% (Figure 4).
Figure 4 - JPST portfolio allocations from early 2023 (am.jpmorgan.com)
I believe the portfolio changes suggest the JPST ETF is getting slightly more aggressive with its allocations. However, all changes are still within the parameters of the fund's mandate.
The JPST ETF currently has an SEC-30 Day yield of 5.4% and has paid a trailing 12 month distribution yield of 4.8% (Figure 5).
Figure 5 - JPST currently has a SEC-30 day yield of 5.4% (am.jpmorgan.com)
Fed Paused; Now What?
In 2023, I was cautious on JPST because during a Federal Reserve hiking cycle, treasury bill yields follow policy rates higher, and any security with duration faced a headwind from higher interest rates (Figure 6).
Figure 6 - Treasury bill yields closely track Fed Funds rates (St. Louis Fed)
However, as we begin 2024, the Federal Reserve have kept its policy rates steady since September and FOMC members have been hinting that the Fed may start cutting policy rates in the next few quarters. In fact, market participants have aggressively priced in 6 policy rate cuts in 2024, even though the FOMC Committee have only forecasted 3 in its latest Summary of Economic Projections (Figure 7).
Figure 7 - Market is anticipating 6 rate cuts in 2024 (CME)
What this pivot in Fed policy means for ultra short-term credit funds like JPST is that the modest amount of duration risk the fund is taking may turn from a headwind into a tailwind, assuming the rate cuts come to fruition in 2024.
JPST Will Likely Outperform Cash Going Forward
I believe this is also the primary reason why the portfolio managers at JP Morgan have modestly increased duration in the JPST ETF, in anticipation of Fed rate cuts in the coming quarters.
Historically, JPST ETF had outperformed its benchmark, the ICE BofA 3-Month US Treasury Bill Index from 2018 to 2021 (Figure 8), when Fed Funds rates and treasury bill yields were flat or declining (Figure 9).
Figure 8 - JPST historical performance (JPST factsheet) Figure 9 - Fed funds rate, 2018 to 2021 (St. Louis Fed)
While I do not believe a return to 0% Fed Funds rate is in the cards in the near term, so JPST is unlikely to outperform treasury bills by 151 bps like it did in 2020, I believe modest outperformance is possible. In 2018 and 2019, the JPST outperformed treasury bills by 32 and 108 bps respectively.
Still, Beware Of Credit Risks
However, although the JPST ETF is likely to outperform money market funds like SGOV in the coming quarters, investors should be aware that there is still credit risk involved when they buy the JPST ETF. In times of market stress, like during the COVID-19 pandemic, credit spreads can be dislocated on corporate bonds and the JPST ETF can suffer MTM losses (Figure 10).
Figure 10 - JPST can suffer steep MTM losses when credit markets become dislocated (am.jpmorgan.com)
So investors should be mindful of this risk when making their portfolio allocation decisions.
Conclusion
With the Federal Reserve on hold and potentially pivoting to policy rate cuts in 2024, JPST will likely return to outperforming money market funds, as its portfolio has duration and credit risk that can act as a tailwind.
However, JPST's modest credit risk can still turn into MTM losses when credit markets become dislocated in times of stress, so investors need to be mindful of this risk.
I believe investors can consider switching out of money market funds like the SGOV and into JPST for their cash allocation. I am raising JPST to a buy .
For further details see:
JPST: Should Return To Outperforming Cash (Rating Upgrade)