JPMorgan Hedged Equity I JHEQX

Effective Feb. 17, 2023, JPMorgan Hedged Equity will again be open to new investors. The fund soft-closed in early 2021, but increased volume in daily S&P 500 index options since then (and expectations that levels will remain adequately high because of increased marketplace participation) assuaged management's previous concerns over the fund’s room to grow. Neither the People nor Process ratings are affected. The fund maintains its Morningstar Analyst Rating of Silver for its cheapest share classes and its Bronze and Neutral ratings for the pricier ones.

JPMorgan Hedged Equity offers investors a transparent, well-defined strategy that will help them remain invested during challenging markets. Its experienced team and reasonable fees earn the strategy a Morningstar Analyst Rating of Silver for its cheapest share classes, while more-expensive share classes are rated Bronze and Neutral.

The strategy aims to provide smoother equity returns by tempering downside and upside returns via a systematically implemented options strategy. At the start of every quarter, the team purchases put options 5% below the S&P 500’s value. To offset the cost of the put option, the team first sells put options 20% out of the money. This structure should generally protect the fund from quarterly losses in the 5%-20% range; if markets fall less than 5%, the fund should fall in line with the market, and if the market falls more than 20%, the fund should incur the same incremental losses beyond negative 5%. The team also sells further call options to generate enough option premium income to cover the remaining cost of the hedges. As designed, the options overlay tempers upside returns in exchange for downside protection, limiting drawdowns to 6.8% for 2022 through August and 4.9% during the first quarter of 2020. Still, returns on the Institutional share class have been robust. Five-year returns through August 2022 sat at just over 7.2% compared with the S&P 500’s 11.8% return. The strategy has shown positive alpha to our category index over all rolling three-year periods bar one since inception, highlighting its ability to add value to a diversified portfolio.

Hamilton Reiner runs the show here. The lead manager and architect of the strategy joined JPMorgan in 2009 and has more than three decades of equity and options trading experience. He is supported by comanager Raffaele Zingone and 24 JPMorgan equity analysts who implement the low-tracking-error equity portfolio the options are built around.

JPMorgan soft-closed the strategy earlier in 2021, a welcome move designed to preserve the smooth operation of the quarterly options reshuffle. The newer Class 2 and 3 versions have picked up some of the slack as investors increasingly diversify across all three implementations of the strategy. The only difference being the month end when then options are executed. While this is still a large fund, given its index aware equity portfolio and index options overlay, capacity is not currently a concern.

Transparency and predictability are hallmarks of this thoughtfully designed options-trading strategy. Its well-defined and disciplined process has produced consistent performance, leading to an Above Average Process rating.

The strategy aims to provide a smoother ride to equity investing by purchasing 5% out-of-the-money put options and selling 20% out-of-the-money put options over a U.S. equity portfolio. This structure, called a put-spread, is designed to protect capital when markets sell off 5%-20% in a given quarter but also has a lower cost compared with outright put protection. However, since the short option position is so far out-of-the-money, management also sells a call option to cover the price of the long put position. The call options are usually sold 3.5%-5.5% out-of-the-money, depending on the amount of income needed to cover the cost of the long put, but periods of heightened volatility can move that target higher. The level at which the call strikes are written will determine the strategy’s upside cap for the quarter.

The team intends to generate a small level of alpha in the equity portfolio by being modestly overweight in attractively priced stocks and slightly underweight in expensive stocks based on fundamental analysis. Since the constitution of the equity portfolio closely replicates the S&P 500, the use of the index options is not problematic from a hedging perspective.

The strategy’s core long equity portfolio should track the S&P 500 closely as it constrains tracking error to 1.5% annually. It aims to outperform that index by tweaking the individual stock exposure within a 1-percentage-point range using a dividend discount model that ranks stocks from most attractive to least attractive based on forecast earnings and company-specific growth catalysts. The team creates a well-diversified portfolio that mitigates risk associated with individual holdings, with the resulting portfolio holding around 200 stocks. Sector weightings resemble the S&P 500 with modest underweightings in healthcare and information technology and a small overweighting in consumer discretionary.

The team constructs a zero-cost option overlay at the beginning of each calendar quarter and resets it at the end of the quarter. Call premiums received should improve with persistently high market volatility and higher interest rates, thus improving the strategy’s upside in such a market environment. This was the case in much of 2020 (call options had a strike price closer to 7% out-of-the-money following a period of extremely high volatility) and parts of 2021. However, in periods of serious market stress (such as Black Monday in 1987, where the S&P 500 dropped 23% in a single day), the short out-of-the-money put leg of the spread may expose the fund to additional losses.

A small yet experienced management team that leverages JPMorgan’s deep resources earn this strategy an Above Average People rating.

The core team tasked with managing this strategy is small, but concerns about its size are mitigated by the options overlay’s systematic implementation and access to a strong support team. Lead portfolio manager and strategy architect Hamilton Reiner joined the firm in 2009 and now has three decades in the derivatives markets. Prior to joining JPMorgan, Reiner held senior positions across Wall Street at Barclays Capital, Lehman Brothers, and Deutsche Bank, and he spent the first 10 years of his career at O’Connor and Associates, an options specialist firm. Although he is the only dedicated investment resource dedicated to executing the options overlay, there is strong institutional framework at JPMorgan supporting the strategy.

Raffaele Zingone, the other named portfolio manager, joined the firm in 1991 and is responsible for the equity portfolio implementation. He directs JPMorgan's deep bench of 24 equity analysts, who average 21 years of industry experience. Consistent with groups this size, there has been modest turnover on the analyst team. Reiner and Zingone both invest more than $1 million alongside investors, signaling a strong alignment of interest between management and shareholders.

A well-resourced, thoughtful, and disciplined steward of client assets, JPMorgan Asset Management maintains an Above Average Parent rating.

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 its December 2013 inception through August 2022, the Institutional shares of the strategy returned 7.26% annualized, beating the options-trading Morningstar Category average by nearly 4.4 percentage points annualized.

The options overlay is designed to protect capital when the S&P 500 drops 5%-20% in a given quarter. This means investors will be exposed to losses if the S&P 500 loses less than 5% in a three-month period. However, this hasn’t stopped the strategy from achieving its goal of lower volatility relative to the S&P 500. Over the trailing five years ended August 2022, its 7.4% monthly standard deviation clocked in lower than the S&P 500's 17.5%. Moreover, the maximum drawdown was limited to negative 9.7% relative to the S&P 500’s negative 19.6%. Even so, JPMorgan has captured more than 44% of the S&P 500’s upside returns over the past five years, limiting downside capture to 36%. Investors should note that the intraquarter experience will vary given that option pricing is dynamic until expiration. Options’ values are marked to market daily, which often results in intraquarter deviations from the quarter-end return. For example, the strategy was down nearly 19% at one point in the first quarter of 2020 but ended the period down 4.9%. On a portfolio basis, the strategy has been additive to a diversified portfolio for all bar one rolling 36 month periods since inception.

Investors should note that the intraquarter experience will vary given that option pricing is dynamic until expiration. Options’ values are marked to market daily, which often results in intraquarter deviations from the quarter-end return. For example, the strategy was down nearly 19% at one point in the first quarter of 2020 but ended the period down 4.9%.

The I class charges a low 0.60% per year