JPMorgan Government Bond A OGGAX

Veteran portfolio managers and a deep supporting cast ably execute JPMorgan Government Bond’s disciplined mortgage-focused mandate.

Comanagers Michael Sais and Bob Manning each have more than three decades of experience managing mortgage-backed securities. The luxury of a deep supporting cast of securitized managers and research analysts makes this team as strong as any in the intermediate government Morningstar Category. Sais takes the lead role here, executing this approach that invests only in US government backed debt, but their expertise in sourcing and selecting various agency MBS structures stands out. The managers tap an eight-person dedicated securitized analyst team for additional bottom-up research.

Disciplined security selection and stable duration highlight the fund’s style. The strategy doesn’t only own Treasuries and agency debt as in the Bloomberg US Government Bond Index. Instead, it features agency MBS, which offer better convexity profiles than plain-vanilla passthroughs. This style results in a more predictable portfolio and stable duration profile, limiting extension in periods of rising yields, for example. While the process considers macro themes, bottom-up security selection drives portfolio construction. Agency-backed residential and commercial MBS and collateralized mortgage obligations typically a 45ccount for %-65% of assets. Treasuries (15%-30%) and agencies (3%-20%) take a supporting role. The fund’s approach to interest rate risk stands out, too, normally keeping duration between 5.0 and 5.5 years.

All bonds in the fund are US government guaranteed, while relative value calls drive subtle portfolio shifts. June 2024’s portfolio featured a mix of Treasuries and agencies (37.8% of assets), agency CMBS (18.3%), agency CMOs (19.5%), residential passthroughs (20.4%), and cash. The managers recently found better value in MBS, increasing its agency pass-through stakes by about 2 percentage points over the past year while reducing agency CMBS and Treasuries. The fund’s 5.7-year duration (as of June 2024) was little changed since a year ago; while the managers have allowed duration to drift slightly above its upper band, don’t expect it to exceed six years.

Long-term performance is compelling. Since January 1997, Sais' first full month on the fund, the institutional shares’ 4.06% annualized return through August 2024 beat its distinct intermediate government peer median’s 3.65% and the Bloomberg US Government Bond Index’s 3.86%. This top-decile result resulted in strong risk-adjusted performance. While the fund’s long-term standard deviation is lower than peers, the fund’s typical longer-duration profile has lagged in shorter-term rising yield periods.

J.P. Morgan’s diligent security selection drives portfolio construction here. The managers’ discipline to buy bonds with better convexity profiles than plain vanilla passthroughs, or those that have more stable durations given changes in underlying yields, results in superior prepayment protection and more predictable results. For example, the team prefers specified MBS pools that have distinct underlying characteristics, CMO structures that target specific cash flows, and CMBS that limit prepayment risk. By contrast, intermediate government bond peers may favor plain-vanilla agency passthroughs or to-be-announced MBS forward contracts that can cause meaningful duration changes.

The fund’s emphasis on agency MBS differs from that of the Bloomberg US Government Bond Index, which only features Treasuries and agency debt. 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 commercial RMBS, CMBS, and CMOs typically make up 45%-65% of assets, while Treasuries (15%-30%) and agency debt (3%-20%) take a supporting role.

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 band of 5.0 and 5.5 years, typically shorter than its index but longer than its typical peer. This approach helps manage investor expectations but limits flexibility to add value over changing rate environments.

While all bonds are US government guaranteed, the team’s constant relative value assessments lead to subtle portfolio shifts over time. As of June 2024, the fund featured a mix of Treasuries and agencies (37.8% of assets), agency CMBS (18.3%), agency CMOs (19.5%), residential passthroughs (20.4%), and cash, little changed from a year prior. This approach allows the fund to outyield its pure Treasury and agency debt benchmark.

The team made modest moves over the trailing 24 months. For example, the team’s outlook for recession led to an increase in the Treasury and agency allocation by about 4.5 percentage points. Within its securitized stakes, better relative value in passthroughs led the team to increase this stake by about 2 percentage points while reducing agency CMBS and Treasuries over the same period. The strategy’s 4.0% cash stake is typical, normally staying between 3% and 6% in cash for liquidity.

Stable duration is a hallmark. June 2024’s 5.7-year portfolio duration was slightly above its normal band yet has remained range bound over time, owing to better portfolio convexity versus other mortgage-focused rivals. The 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 6.0 years.

The fund’s High People rating recognizes J.P. Morgan’s veteran managers and the firm’s collective MBS expertise.

Comanagers Michael Sais and Bob Manning bring a wealth of experience, especially within agency MBS. Sais, who takes the lead on this strategy, began his J.P. Morgan career as an MBS research analyst before rising to comanager in 1997. Manning’s contributions to the firm’s fixed-income efforts span more than 25 years; he joined the fund in 2013 to add depth and lessen key-person risk. They also comanage the JPMorgan Limited Duration ETF.

Alongside this duo, the firm’s large network of fixed-income specialists helps to guide macro positioning and contributes to bottom-up ideas and security selection. Experience matters when sourcing and selecting bonds that meet the managers’ stringent standards. The managers conduct much of their bottom-up research and trading but also draw on specialized portfolio managers and a growing team of securitized analysts. An eight-person fundamental research cohort, led by Sajjad Hussain since 2021, is responsible for securitized analysis and monitoring, and it 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 been stable, with no turnover of any key contributors over the past five years; it added another securitized analyst in mid-2024. The managers’ personal ownership in the fund is mixed: Sais’ personal stake in the fund exceeds $1 million, but Manning has none, which is disappointing as high manager ownership fosters a better alignment with investors.

J.P. Morgan is a well-resourced, diligent, and responsible steward of client assets. Investment teams are seasoned and stalwart, especially in equity and fixed income, the latter of which has successfully undergone substantial transformation in recent years. The firm offers competitive compensation that is aligned with fundholders and shows strong retention at senior levels of the organization. It demonstrates a culture of constant innovation and willingness to evolve. For example, J.P. Morgan recently expanded its investment committee process through which senior leaders review various teams and strategies, and it continues to develop proprietary portfolio management and risk oversight tools. Some funds still face high fee hurdles, but the firm has generally lowered expenses as it has grown.

The firm isn't without its complications. J.P. Morgan's product offering is extensive, and some areas need improvement. For instance, its multi-asset business has faced some challenges as a result of complex investment processes. The firm continues to build out its footprint in China, but its efforts there remain unproven. Although not every strategy is the best in its class, J.P. Morgan remains earnest in the pursuit of excellence, and investors are well-served.

Strong security selection and structural biases to agency MBS provide a yield advantage versus its pure Treasury and agency debt index and intermediate government category peers.

Since Michael Sais’ first full month on the fund in January 1997, the Institutional share class’ 4.06% annualized return through August 2024 beat its unique peer median’s 3.65% and Bloomberg US Government Bond Index’s 3.86%. This result landed the fund in the category’s top decile; its Sharpe ratio (a measure of return relative to standard deviation) was better than three fourthss of category rivals.

With the fund’s tight duration band, normally longer than its peers', investors may experience a bumpier ride at times. In most periods, the fund is more sensitive to yield changes and may lag in over the short term. However, the strategy has delivered better, more predictable results versus rivals when yields fall. 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.

For the year to date through August 2024, the fund’s 3.2% return was slightly better than its benchmark’s 2.6% gain and in line with peers; the fund’s yield advantage versus the index has helped thus far.

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.