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Keeping it Short With Bonds is Paying Off

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Reacting to rising interest rates, fixed income investors often shift to lower duration bonds and the related funds, a move that has been on full display this year. Of the two fixed income exchange traded funds (ETFs) that are among this year’s top 10 asset-gathering ETFs, both are low or ultra-low duration products.

Conversely, the three bond ETFs populating the list of the 10 worst ETFs in terms of assets lost are medium-term bond funds. Some newer ETFs are benefiting from investors’ thirst for ultra-low duration fare, including the JPMorgan Ultra-Short Income ETF (JPST). The JPMorgan Ultra-Short Income ETF debuted in mid-May 2017. Thanks to year-to-date inflows of $3.59 billion, the JPMorgan Ultra-Short Income ETF had $3.70 billion in assets under management as of November 16th, easily making it one of the most successful bond ETFs to launch last year.

The fund aims for a duration of one year or less. That objective is being accomplished with ease as highlighted by JPST’s duration of 0.53 years as of October 31st. By comparison, the widely followed Bloomberg Barclays US Aggregate Bond Index has an effective duration of 5.85 years. While JPST actively seeks to manage interest rate risk, it is able to capture a significant percentage of the Bloomberg Barclays US Aggregate Bond Index’s yield, as the chart below indicates.

COURTESY: JPMorgan Asset Management

As of November 16th, the JPMorgan Ultra-Short Income ETF had an unsubsidized 30-day SEC yield of 2.71 percent compared with 3.35 percent on the Bloomberg Barclays US Aggregate Bond Index, but a fair trade nonetheless when considering JPST’s significantly lower duration.

Credit Concerns

Rising interest rates are not the only catalyst stoking inflows to funds such as the JPMorgan Ultra-Short Income ETF. Concerns that credit markets are deteriorating are increasing the allure of short-term bond funds as well. A couple paragraphs earlier, we mentioned three bond ETFs among the 10 worst for assets lost this year. All three are corporate bond funds, including two junk bond products.

“More investors are growing cautious about the corporate debt market, with heavily debt-laden companies like General Electric Co., Ford Motor Co. and Campbell Soup Co. flashing warning signs as global growth slows and interest rates rise,” according to Bloomberg.

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Compounding concerns in the corporate bond market are the rising number of bonds with BBB ratings, meaning those issues sit one to three rungs away from junk territory. By some estimates, half the U.S. investment-grade bond market has a BBB rating of some kind. If a spate of downgrades ensues, investors, fund managers restricted to owning investment-grade debt will be forced to depart those fallen angels, pressuring the high-yield bond market along the way.

There are no guarantees those downgrades will happen, but price action confirms JPST has been a better bet this year than the largest investment-grade and high-yield bond ETFs.

Corporate bonds, though prized for income-generating traits, can increase a fixed income portfolio’s volatility whereas a an ultra-low duration strategy like JPST can reduce a portfolio’s overall volatility.

While short-term bonds are not likely to keep pace with equity returns over long holding periods, current yields on funds such as the JPMorgan Ultra-Short Income ETF (JPST) have these products positioned to be sources of refuge for investors in what could be an increasingly stormy environment for bonds.

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