JPMorgan Government Bond A OGGAX

JPMorgan Government Bond’s seasoned managers bring extensive securitized debt experience. This team and vast supporting cast execute this disciplined, value-driven process, earning an upgraded People rating.

Comanagers Michael Sais and Bob Manning each bring over three decades of experience, but they don’t do it alone. A deep supporting lineup of managers, research analysts, and traders propel this strategy’s People rating to High from Above Average. They consistently execute this straightforward approach that only invests in U.S.-government-backed debt, but their expertise in sourcing and selecting various agency mortgage-backed securities structures stands out. Alongside the managers, a seven-person dedicated securitized analyst team helps with bottom-up research.

The fund forges its own path. Stringent security selection and stable duration highlight the fund’s approach, while its Bloomberg U.S. Government Bond Index, which only features U.S. Treasuries and agency debt, is only a loose proxy. Instead, the fund features agency MBS of various structures designed to offer an attractive yield and stable duration profile, limiting extension in periods of rising yields. While the process considers macro themes, bottom-up security selection drives portfolio construction. Agency-backed residential and commercial MBS and CMOs typically comprise 45%-65% of assets while U.S. Treasuries (15%-30%) and agencies (3%-20%) take a supporting role. The fund’s approach to interest rate risk stands out, normally keeping duration between 5.0 and 5.5 years.

The managers don’t make big moves, but methodically adjust exposures consistent with their macro-outlook and relative value views. Recently, their forecast for a recession has led to an increase in the fund’s U.S. Treasury and agency debt allocation to about 38.2% of assets, its highest level since 2019 and about 5 percentage points higher than a year ago. The team currently favors better prepayment protection of agency CMBS and well-structured CMOs over pass-throughs. While the fund's 5.87-year duration (as of August 2023) has risen slightly above its upper band, it’s much more stable than its typical rival over time.

The fund has an enviable long-term record. Since Sais’ first full month on the fund in January 1997, the Institutional share class’s 4.0% annualized return through August 2023 beat its unique intermediate government Morningstar Category median peer’s 3.5% and Bloomberg U.S. Government Index’s 3.8%. This result landed in the category’s top decile. Its Sharpe ratio, a measure of returns relative to standard deviation, was better than 75% of its category rivals.

J.P. Morgan has honed its process that relies on various macro inputs, diligent bottom-up security analysis, and disciplined duration positioning to earn an Above Average Process rating.

The fund’s Bloomberg U.S. Government Bond Index, which only features U.S. Treasuries and agency debt, is only a loose proxy for this fund that emphasizes agency mortgage-backed securities. While the process begins with J.P. Morgan's quarterly investment meeting that sets macro themes for the subsequent three to six months, bottom-up security selection drives portfolio construction. Agency-backed residential and commercial MBS and CMOs typically comprise 45%-65% of assets while U.S. Treasuries (15%-30%) and agency debt (3%-20%) take a supporting role.

Diligent security selection is key, and the team is picky about what they own. For years, they’ve focused on bonds with better convexity profiles, or those that have more stable durations given changes in underlying yields. This results in superior prepayment protection and a more predictable performance. Examples include CMO structures that target specific cash flows, specified MBS pools that have distinct underlying characteristics, or CMBS that limit prepayment risk. By contrast, the intermediate government bond peers may favor plain-vanilla agency pass-throughs that can cause meaningful duration changes.

This strategy’s approach to duration is unique. It doesn’t follow the index, but instead usually keeps duration, a measure of interest rate sensitivity, between a narrow 5.0- and 5.5-year band, typically shorter than its index but longer than its average peer. This makes the fund more predictable but limits flexibility to add value over changing rate environments.

Constant relative value assessments mean the fund’s profile subtly shifts over different periods. As of June 2023, the fund featured a mix of U.S. Treasuries and agencies (38.2% of assets), agency CMBS (18.8%), agency CMOs (19.9%), residential passthroughs (18.0%), and cash. This approach allows the fund to outyield the all-Treasury and agency debt Bloomberg U.S. Government Bond Index.

Macro themes guide broad sector moves, but bond structure and relative valuations drive security selection. For example, the team’s outlook for recession led to an increase in the fund’s U.S. Treasury and agency allocation to its highest level since 2019 and about 5 percentage points higher than a year ago. Within its securitized stakes, they've slightly reduced its pass-through exposure, instead favoring agency CMBS and well-structured CMOs that offer better prepayment protection. The strategy’s 4.6% cash stake is typical, typically keeping between 3%-6% in cash for liquidity.

Stable duration is a hallmark. While the strategy’s current 5.87-year duration is slightly above its normal duration band, it has remained range-bound over time, owing to better portfolio convexity. Meanwhile, its typical peer’s duration is more variable; since the beginning of 2022, the median peer’s 4.7-year duration lengthened quickly to about 6.0 years at the end of the year as yields rose and prepayments slowed. While the managers have allowed duration to drift slightly above its 5.5-year upper band more recently, don’t expect it to exceed six years.

The veteran managers and collective expertise of J.P. Morgan’s mortgage-backed securities specialists and vast fixed-income resources earn a People upgrade to High from Above Average.

Mainstays Michael Sais and Bob Manning bring a wealth of experience, especially within agency MBS. Sais’ J.P. Morgan career began as an MBS research analyst before joining the fund as a comanager in 1997, while Manning’s contributions to the firm’s fixed income efforts span more than three decades; he joined the fund in 2013 to add depth and lessen key-person risk. They also comanage the JPMorgan Limited Duration ETF JPLD.

Alongside this duo, the firm’s large network of fixed-income specialists helps to guide macro positioning and contribute to bottom-up ideas. Experience matters when sourcing and selecting bonds that meet the managers’ stringent standards. The managers conduct much of their bottom-up research but also draw on specialized portfolio managers and a growing team of securitized analysts. A seven-person fundamental research cohort, led by Sajjad Hussain since 2021, is responsible for analysis and monitoring, and collaborates with the managers on investment ideas. This tight-knit team jointly makes portfolio decisions and works out any differences in the best interests of the fund.

This team has also been stable, with no turnover of any key contributors over the past five years, and plans to add another securitized analyst. Managers’ personal ownership in the fund is mixed, though. Sais’s personal stake in the fund exceeds $1 million but Manning has none, which is disappointing as high manager ownership fosters a better alignment of interest 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.

Driven by strong security selection, the fund’s structural biases to agency mortgage-backed securities versus its 100% U.S. Treasury and agency debt index give it a yield advantage.

Since Michael Sais' first full month on the fund in January 1997, the Institutional share class’s 4.0% annualized return through August 2023 beat its unique intermediate government Morningstar Category median peer’s 3.5% and Bloomberg U.S. Government Index’s 3.8%. This result landed in the category’s top decile. Its Sharpe ratio, a measure of returns relative to standard deviation, was better than 75% of its category rivals.

With the fund’s tight duration band, normally longer than peers, investors may experience a bumpier ride at times. In most periods, the fund is more sensitive to yield changes, resulting in better results versus rivals when yields fall and underperforming when yields spike. For example, when yields fell in 2019, the fund’s 6.6% gain outpaced its median peer’s 6.2%, but amid 2022’s spike in long-term yields, the strategy’s 11.9% loss was slightly more severe than the median peer’s 11.5% drop.

Year-to-date through August 2023, the fund’s 0.9% return was slightly better than its benchmark and in line with peers, driven by tighter MBS spreads and a slight duration underweight versus the index.

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.