JPMorgan Diversified Return US Eq ETF JPUS

JPMorgan Diversified Return U.S. Equity ETF JPUS avoids concentration and bends toward valuable risk factors, but its unique construction introduces risks that can get in their way.

The JPMorgan Diversified Factor US Equity Index underpinning this fund targets stocks with the best combination of value, momentum, and quality characteristics. With robust track records of market-beating returns, these risk factors are a worthy pursuit. Measuring stocks’ collective traits rather than building separate sleeves improves factor exposure. Indeed, the fund has effectively channeled the value and quality factors, both of which should enhance returns. Momentum is harder to capture because of inverse-volatility weighting, but it can still filter out risky firms whose prices reflect trouble that their prices don’t.

Diversification across factors and stocks is a priority here. Different risk factors like value and quality tend to excel at different times. The fund’s weighting scheme, which weights sectors by their inverse volatility and stocks near-equally, promotes diversification as well. At the end of November, no sector exceeded consumer staples’ 14% portfolio weighting. The 10 largest holdings constituted 4.6% of the portfolio compared with 17.1% for the Russell 1000 Value Index, its Morningstar Category benchmark. Avoiding concentration should help this fund avoid shocks that hurt only one segment of the market.

This fund’s unique and convoluted construction makes this portfolio look quite different from the category index and broad market. Just 37% of it overlapped with the Russell 1000 Value Index, and just 32% of it with the Russell 1000 Index. Sector biases explain much of the difference. This fund’s utilities, real estate, and consumer staples sectors exceeded the Russell 1000 Value by about 5 percentage points apiece, while it was 12 percentage points underweight in financials. Sector bets do not always work, and they can drown out the effect of factors, which are more reliable performance engines.

That was the case over 2022, a year that should have benefited this inverse-volatility-weighted portfolio and the stability it should confer. Hamstrung by its unfavorable technology and energy allocations, the fund fell 97 basis points further than the Russell 1000 Value Index and ranked within the bottom quartile of large-value peers. The fund’s track record has remained solid since its 2015 inception, but sector risks and complex construction leave doubts over the durability of that strong performance.

It earns an Average Process Pillar rating.

This fund starts by assigning each Russell 1000 Index constituent a composite factor score that measures its value, momentum, and quality traits relative to its sector peers. Price multiple ratios like price/book determine the value score, and risk-adjusted 12-month performance defines momentum. Quality embodies various metrics that describe companies’ profitability, solvency and financial risk, and earnings quality. The composite factor score equally weights all three factors. By evaluating the combination of firms’ factor traits rather than building distinct sleeves, the index rewards stocks with balanced profiles and positions itself for more potent multifactor exposure.

The index next establishes its sector allocation by measuring the inverse three-year standard deviation of equal-weighted sector subindexes. Lower volatility translates into higher sector weightings. The index fills each sector bucket with stocks whose composite factor scores ranked the best. Rather than target a number of stocks in each sector bucket, the index adds constituents at weightings between 0.3% and 0.4% of the total portfolio until the bucket fills up. This equal-weight-adjacent tactic means the number of stocks from each sector mostly depends on the sector weighting.

Several constraints preserve index liquidity and diversification. In a notable zag to most competitors’ zig, the index features a minimum turnover constraint: at least 5% of the portfolio is refreshed at each quarter’s rebalance to preserve factor exposure. It hasn’t sparked too much activity. This fund’s annual turnover ratio ranked well within the category’s lower half in each of its six full calendar years on the market.

This portfolio favors companies with well-rounded factor resumes to those that measure up well in one area but poorly in others. For instance, retail REIT Simon Property Group SPG earns a spot in this portfolio thanks to its solid value, quality, and momentum chops, although none of them jump off the page. On the other hand, firms with exceptional valuations, profits, or recent returns don’t make the cut if they lack the other bona fides.

This holistic measurement translates into strong factor tilts, especially for value and quality. The portfolio trades at valuations similar to the Russell 1000 Value Index despite targeting stocks from all over the value-growth spectrum. It generated return on invested capital (a measure of profitability) that exceeded the category benchmark by nearly 40% on average over the past five years. Momentum is harder to capture because of the fund’s weighting approach and the immense turnover it requires. Still, according to the Morningstar Risk Model, the portfolio sported stronger momentum exposure than the category benchmark and most peers as of November 2023.

Since each holding weighs between 0.3% and 0.4% after each rebalance, this portfolio comes with hardly any firm-specific risk. Its top 10 holdings accounted for an average 5% of assets since inception, about one fourth of the category index’s ratio. Sector allocations are spread out as well; none exceeded consumer staples’ 14% weighting as of November 2023.

While they don’t soak up much of the portfolio, some sector weightings stick out versus the category index and broad market. Consumer staples, real estate, and utilities collectively represented one third of the portfolio at November’s end, about triple their share of the Russell 1000 Index. Those outsize stakes were funded by relatively light exposure to tech and financials stocks. These lopsided sector bets are not a reliable performance engine and threaten to drown out the fund’s factor tilts.

The team has the tools and experienced personnel necessary to provide tight index tracking, but it does not have the resources of its larger competitors. It earns an Average People Pillar rating.

J.P. Morgan's quant beta solutions team was formed in January 2017, when it took over management of this fund and J.P. Morgan's other strategic-beta exchange-traded funds. Four portfolio managers share responsibility for this portfolio. Yaz Romahi serves as the team's CIO and helped develop the strategy. Natalia Zverva replaced Alistair Lowe on the fund in November 2022. Joe Staines and Steven Wu round out the lineup.

Most of the team's workflow is conducted through Spectrum, J.P. Morgan's in-house portfolio management platform, which automates many aspects of day-to-day workflow. Two risk oversight teams monitor the funds managed by the quant beta solutions team. Both provide tracking-error targets, and tracking performance is formally reported each quarter. The managers' compensation is tied to tracking performance, aligning their interests with investors'.

As of 2022, this investment stalwart manages more than USD 2.5 trillion in AUM. Composed of various global cohorts and diverse asset classes, the firm has more tightly integrated its capabilities in recent years, notably through the development of proprietary analytical and risk systems. Investment teams are robustly staffed and helmed by seasoned contributors. The firm’s strategies tend to produce reliable portfolios, and several flagship offerings are Morningstar Medalists. Manager incentives align with fundholders'; compensation reflects longer-term performance factors, and portfolio managers invest in the firm’s strategies as part of their compensation plans.

The firm’s funds tend to be well-priced, but they aren’t as competitive as many highly regarded peers of similar scale. Recent product launches include thematic and single-country strategies, both of which carry the potential for volatile performance and flows, along with misuse by investors. The firm remains intrepid when it comes to developing an environmental, social, and governance-focused framework and continues to move into other areas such as direct indexing through its 55iP acquisition and China through its joint venture, but these complicated initiatives take time to assess any real and lasting effect.

From that point through November 2023, its 10.6% annualized gain trumped the category index’s by about 1.1 percentage points per year. It also posted lower volatility over that span, nudging its Sharpe ratio(a measure of risk-adjusted return) into the large-value category’s best quartile.

This fund hasn’t behaved like a typical low-volatility strategy, even though it favors the market’s sturdiest sectors. It built a lead on the Russell 1000 Value Index when markets rallied: In its three best calendar years (2017, 2020, and 2021), the broad market climbed more than 20%. Some of that owes to its quality component, as stakes in profitable market leaders like Nvidia NVDA and Microsoft MSFT bolstered returns in those years. Relatively large allocations to basic materials and consumer discretionary names were a boon, too.

On the flip side, the fund has not been trustworthy during market drawdowns. It has captured just 91% of the Russell 1000 Value Index’s downside since inception but wobbled during recent pullbacks. It slid further than the category benchmark during the early-2020 pandemic-fueled selloff, then ranked among the bottom quartile of the large-value peer group in 2022. Uneven sector allocations hampered the fund in both periods, a testament that sector bets can hurt as much as they help.

Based on our assessment of the fund’s People, Process, and Parent Pillars in the context of these expenses, we don’t think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Medalist Rating of Neutral.