JPMorgan BetaBuilders $ HY Corp Bnd ETF BBHY

We have qualitatively reviewed this strategy and reaffirmed its Average People and Average Process ratings. JPMorgan BetaBuilders USD High Yield Corporate Bond ETF BBHY overhauled its strategy in early 2023. Its new passive approach brings some perks and comes with a lower fee. That said, indexing the high-yield bond market presents challenges that curb the fund’s appeal. The following text is from Jan. 30, 2023.

The ICE Bank of America U.S. High Yield Index, which this ETF will track, faces challenges that stem from the market it targets rather than flaws in its own construction. The index absorbs sub-investment-grade corporate bonds with at least $250 million in face value outstanding, weights them by market value, and rebalances monthly. Market value weighting works well in most markets. But high-yield bonds are illiquid, so their prices don’t always reflect all available information about their value. Active funds can exploit this mispricing for profit, forcing this price-taking benchmark to play catch up.

While more rigid than its active peers, the new benchmark mimics the dimensions of the high-yield bond Morningstar Category average. The portfolios share similar duration profiles and corporate bond sector exposure. The index shoulders more credit risk than average because it can’t reach into investment-grade territory, but it doesn’t look too much riskier than the average peer. Avoiding pronounced active bets along credit, sector, or duration lines increases the impact of the fund’s low fee, which should aid category-relative performance.

A broad reach should help this fund deliver above-average yield. Admitting thinly traded issuances to the index can require steeper trading costs, but many of these securities offer healthier yield in return.

Lower stakes in cash and investment-grade debt have made index performance more volatile than the category average. Higher risk has translated into higher reward: after adjusting for fees, this index outpaced the category norm by 1.33 percentage points over the 15 years through 2022.

This report was updated to clarify language around risk.

The following text is from Jan. 30, 2023.

A broad reach and market-value weighting help the new strategy stay diversified, but risks endemic to the high-yield market make it difficult for passive investing to consistently succeed. The fund earns an Average Process Pillar rating.

J.P. Morgan uses an optimizer to track its benchmark. It’s a sensible solution. Rather than invest in thousands of index constituents, a custom-built optimizer constructs a portfolio that mimics the benchmark’s duration, yield, convexity, sector exposure, and other risk dimensions. This should prove to be a cost-efficient way to track the sprawling index.

The ICE Bank of America U.S. High Yield Index, which underpins this fund, sweeps in U.S. dollar-denominated, sub-investment-grade corporate debt from the public U.S. market. Eligible bonds must have at least $250 million in outstanding value, one year until maturity at the rebalance date, and 1.5 years until maturity at issuance. The index excludes all municipal debt, equity-linked securities, Eurodollar bonds, and contingent capital securities, except for those triggered at the discretion of regulators.

Bonds that meet the criteria are weighted by their market value. That pulls the portfolio toward the heftiest issuers, which may be sensitive to economic conditions and vulnerable to drawdowns.

Sub-investment-grade corporate bonds fill this portfolio. Issued by firms like Ford and Charter Communications—the benchmark’s two heaviest issuers—these bonds offer attractive yield to compensate for the default risk attached to them. Issuers should meet these obligations when markets are smooth, but difficult environments may spell trouble for these bonds given the financial instability of the companies that issue them.

This portfolio will be one of the broadest in the category when it adopts its new benchmark. Its $250 million face value requirement is lower than most index funds, opening the door for an array of bonds spanning various corporate sectors. The index does not cap individual issuer weights, but concentration should not be a concern. Bonds from Ford, the portfolio’s top issuer, only represented about 2% of the index entering 2023.

Unlike this fund, active peers may hold investment-grade debt, which could make the index’s credit profile slightly riskier than some. But this fund holds a smaller portion of its portfolio in bonds from the riskiest issuers—those with below B credit ratings—which offsets any disadvantage from its high-yield-only mandate. Overall, it still reflects the shape of the category average. Both favored industrial and consumer cyclical bonds at the end of 2022, when each corporate sector represented about one fifth of the index portfolio. The index and its average peer’s average effective duration hovers around four years, so interest-rate fluctuations shouldn’t drive relative performance. The new version of this fund won’t have the flexibility it once did, but it captures enough of the high-yield bond opportunity set for its low fee to take center stage.

The following text is from Jan. 30, 2023.

The team that will lead this fund is relatively new to the world of fixed-income index tracking and light on personnel. Still, it reaps the benefits of sitting within a robust organization and aligns its interests with investors. On balance, the team earns an Average People Pillar rating.

Four portfolio managers will be named to the fund when it completes its overhaul. Two of them, Naveen Kumar and Qiwei Zhu, helped steer the fund under its previous mandate. Eric Isenberg and Jonathan Msika are new additions. Each was on board when J.P. Morgan launched its first index-tracking bond ETF in 2018, overseeing that fund and others launched since then. That track record makes the team fairly new, but it has effectively tracked benchmark indexes using a team-based approach.

The managers sit in the Global Fixed Income, Currency, and Commodities Quantitative Solutions organization, which is leaner than better-entrenched ETF providers’ outfits. That said, the team oversees fewer funds and reaps the benefits of operating within a robust parent company. Workflow is mostly automated through Spectrum, JPMorgan’s in-house portfolio management platform that receives constant support from a dedicated technology team. Trades flow through the global trading desk. These resources lighten the team’s load and should help it hew close to the index.

Tracking error versus the benchmark drives most of the team’s performance measures. Managers’ variable compensation is tied to that figure, 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.

The benchmark minus the fund’s 0.15% annual expense ratio would have climbed roughly 5.8% annualized over the 15 years through 2022 — over 1 percentage point annualized ahead of its average peer. That required more volatility, but the Sharpe ratio, a measure of risk-adjusted performance, still ranked within the top third of the high-yield peer group.

Averting cash and investment-grade debt makes this benchmark more volatile than the more conservative funds that populate the high-yield bond category. The index less fees was about 10% more volatile than its average peer over the past 15 years, as measured by standard deviation of returns. Widening credit spreads can pose problems for the fund, but it should fare well if they contract. For example, the fee-adjusted index slid about 1.5 percentage points further than its average peer during the pandemic-fueled selloff in early 2020 but beat it by nearly 1 percentage point in the rebound over the second half of that year.

While longer-duration funds faced the toughest headwinds in 2022, loading up on credit risk was not a recipe for success. The benchmark less fees trailed the category average by about 1 percentage point in 2022, true to its boom-or-bust profile.

Based on our assessment of the fund’s People, Process, and Parent Pillars in the context of these expenses, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Medalist Rating of Bronze.