JPMorgan Mortgage-Backed Securities A OMBAX

JPMorgan Mortgage-Backed Securities’ experienced securitized specialists ply a disciplined process focused on an array of mortgage-backed bonds. The fund’s cheapest share class earns a Morningstar Analyst Rating of Silver, while pricier share classes are rated Bronze and Neutral.

Experience, depth, and mortgage-backed securities expertise give this team its edge versus rivals. Michael Sais has managed this fund since 2005, but Rick Figuly (2015), head of JPMorgan’s value-driven core bond team, and Andrew Melchiorre (2019), an MBS specialist, oversee the day-to-day operations of this strategy. These comanagers lean on the firm’s large team of investment-grade portfolio managers and seven securitized analysts.

The strategy’s MBS emphasis distinguishes it from intermediate core bond Morningstar Category peers and takes advantage of its team’s securitized expertise. While the process begins with JPMorgan’s quarterly investment committee forming its three- to six-month macroeconomic outlook, weekly sector meetings and daily interactions drive decision-making here. These value-driven managers apply rigorous fundamental analysis to agency and nonagency MBS of varying types and structures to seek out good relative value and favorable prepayment characteristics. Agency-backed residential and commercial mortgages dominate the portfolio, typically 65%-75% of assets, which differentiates the strategy from peers that often maintain stakes in bonds of this ilk that range from 20%-25% of assets. The fund complements its agency-backed stake with nonagency residential and commercial MBS and asset-backed bonds, while the team maintains a small U.S. Treasury position to bolster liquidity.

The strategy’s contours differ from many of its category peers. Its lack of corporate bond exposure causes it to lag more credit-focused options when markets embrace risk, but in broadly risk-averse markets, its high-quality, mortgage-centric holdings tend to give it a boost. This resiliency, paired with the team’s strong security selection and subtle shifts across securitized sectors, has paid off with impressive performance over Sais’ July 2005-August 2022 tenure. The I share class’ 3.8% annualized return outpaced its median distinct rivals’ 3.2%, landing in the top decile of its peers and delivering a category-best Sharpe ratio, a measure of risk-adjusted returns.

The process begins with JPMorgan’s quarterly investment meeting, which sets macro themes for the subsequent three to six months, while weekly sector meetings focus on relative value and tactical portfolio positioning. Frequent informal communication between portfolio managers and analysts drives security selection.

Bottom-up analysis of MBS is a fixture of this team’s process. The strategy’s stake in a variety or agency mortgage-backed assets makes up the bulk of the portfolio (65%-75%), while the remainder (10%-30%) consists of a mix of U.S. Treasuries, commercial MBS, nonagency MBS, and asset-backed securities. Agency residential pass-throughs and collateralized mortgage obligations are the team’s focus, though they will not hesitate to rotate through other securitized areas where valuations and convexity profiles are attractive. The team keeps duration within a year of its Bloomberg U.S. Mortgage Backed Securities Index to mitigate interest-rate risk and typically shorter than the category’s Bloomberg U.S. Aggregate Bond Index and peers owing to changes in prepayment assumptions of mortgage-backed assets. The managers judiciously use mortgage derivatives such as principal- and interest-only bonds given the higher volatility of these structures.

This strategy’s heavy emphasis on agency MBS and other nonagency securitized bonds differentiates it from intermediate core category rivals that typically manage diversified portfolios of U.S. Treasuries, investment-grade corporates, and agency MBS that are more in line with the category’s Aggregate Index benchmark.

Though agency MBS and CMBS (a combined 67% of assets) dominated the portfolio as of August 2022, the managers trimmed this stake by about 3 percentage points since the same time last year. Within that allocation, the team reduced its RMBS stake in favor of the better prepayment protection offered by CMBS; as of August 2022, the fund’s agency RMBS exposure fell to 50% from 62% since the beginning of the year, while its agency CMBS position rose to 17% from 8%. Over the same period, its Treasury allocation fell to 6.7% from 8.0% to rotate into higher-yielding assets.

The vast majority of this portfolio consists of AAA bonds (78% as of August 2022), and the managers prefer to take credit risk within its nonagency securitized bucket (25%) over corporates, which are nonexistent in the fund. The latter sleeve’s largest allocation went to nonagency residential mortgages (13%), including modest allocations to nonrated nonperforming loans (3%) and reperforming loans (2%). At the same time, nonagency CMBS made up about 10%, 2 percentage points higher than a year ago, while a small ABS position rounded out the portfolio.

Experience and specialized mortgage expertise give this team its competitive edge. Michael Sais, Rick Figuly, and Andrew Melchiorre lead this strategy. Sais began his JPMorgan career as an MBS research analyst and joined here as a manager in 2005. Figuly (2015), head of the firm’s value-driven core bond team, and Melchiorre (2019), an MBS specialist who adds depth and lessens key-person risk, oversee the day-to-day operations of this fund.

The comanagers conduct much of their own bottom-up research and trading for the portfolio but draw on the deep team of investment-grade portfolio managers and seven securitized analysts for macro positioning and idea generation in opportunities that represent good relative value. This tight-knit team jointly makes portfolio decisions and works out any differences in the best interests of the fund.

This is a stable group with no recent turnover of any member directly involved in the strategy, and the team recently added two experienced securitized credit analysts. Sais shares in the fund’s performance with a personal investment exceeding $1 million, while Figuly and Melchiorre each own between $100,000 and $500,000.

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.

Over Michael Seis’ July 2005-August 2022 tenure, the I share class’ 3.8% annualized return outpaced its median distinct rival's 3.2%, landing in the top decile of intermediate core category peers. The fund’s MBS bias has helped versus the category’s diversified Aggregate Index benchmark, which includes U.S. Treasuries, agency MBS, and investment-grade corporates. The team’s MBS acumen has contributed to a category-best Sharpe ratio, a measure of risk-adjusted returns, over the same period.

The fund’s mortgage-centric profile will cause it to behave differently at times from many of its rivals. In periods that favor corporate credit, it has lagged peers that keep larger portions of their portfolio in this sector. For example, when credit spreads tightened throughout 2019, the fund’s 6.6% gain trailed its median peer’s 8.6%. However, this fund comes to the fore in risk-off credit markets; when credit concerns caused wider spreads in 2021, the fund’s 0.4% drop was less severe than the 1.5% loss of its typical rival.

Duration tends to be shorter than its category’s index and typical peer, which helps it hold up better during interest-rate shocks. This profile proved itself in the year to date through August 2022, when the strategy’s 7.5% loss was roughly 3.4 percentage points less severe than its typical competitor as long-term yields rose.

The share class on this report levies a fee that ranks in its Morningstar category’s second-costliest quintile. That’s poor, and based on our assessment of the fund’s People, Process and Parent pillars in the context of these fees, we don’t think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Neutral.