JPMorgan Mortgage-Backed Securities I OMBIX

JPMorgan Mortgage-Backed Securities’ experienced securitized managers, disciplined process, and strong decisions make it a compelling option for investors.

Firm veterans Rick Figuly, Andy Melchiorre, and Michael Sais have used their mortgage-backed securities expertise to generate impressive results. Their bottom-up efforts give them an edge versus most rivals. Sais has run this fund since 2005, but Figuly (2015), the head of J.P. Morgan’s value-driven core bond team, and MBS specialist Andrew Melchiorre (2019) oversee the day-to-day management. It’s very much a team effort, though, with the managers’ fundamental research efforts. They also draw on additional MBS specialists and a growing eight-person securitized analyst group for ideas and ongoing monitoring.

The strategy’s heavy MBS stakes differentiate it from intermediate core bond peers who typically manage to the Bloomberg US Aggregate Bond Index, which features a mix of Treasuries, investment-grade corporates, and agency MBS. The portfolio consists of agency residential and commercial MBS, typically accounting for 65%-80% of assets. This sets it apart from the typical peer, which has historically ranged between 25% and 30% for similar bonds.

J.P. Morgan's quarterly investment committee shapes the fund’s macro positioning. However, most of the work takes place in weekly sector meetings and daily interactions to inform portfolio construction. These value-driven managers employ rigorous fundamental analysis to evaluate various agency and nonagency MBS structures that meet their stringent standards, which identify bonds with favorable prepayment characteristics and good relative value.

The strategy’s unique contours, including its absence of corporate bonds, can cause it to lag most rivals in periods of corporate bond stress, but its high-quality, mortgage-centric holdings give it a boost when credit is out of favor. This resiliency, as well as strong security selection, have paid off for investors. Over the trailing 10 years, the I shares’ 2.1% annualized return through August 2024 beat its distinct intermediate core bond rival’s 1.7% and the benchmark’s 1.6%. This top-decile result was even better when adjusting for volatility.

The portfolio emphasizes MBS with relative cash flow stability and prepayment protection. The process begins with J.P. Morgan’s quarterly investment meeting, which sets macro themes for the subsequent three to six months, while weekly sector meetings stress relative value ideas and tactical portfolio positioning. Effective daily collaboration and robust discussions between the managers, securitized specialists, and analysts ensure the best ideas make it into the portfolio. The managers are very selective about the bonds that make the cut, and they focus their research on underlying pool analysis, cash flow stability, and relative value to drive security selection. Their penchant for MBS structures that limit prepayment sensitivity avoids generic passthroughs or to-be-announced forward contracts, instead favoring specified pools with specific characteristics. This results in a resilient portfolio.

The managers keep the Bloomberg US MBS Index in mind when building the portfolio. Stakes in a variety of agency mortgage-backed assets make up the bulk of the portfolio (65%-80%), while the remainder (10%-30%) consists of a mix of Treasuries, CMBS, nonagency MBS, and ABS. Duration (a measure of interest-rate sensitivity) and yield-curve calls are secondary; the team keeps duration within 1.0 year of its benchmark, which is typically more fluid and shorter than that of most peers and the Aggregate Index. The managers use mortgage derivatives (such as principal- and interest-only bonds) moderately given the higher volatility of these structures.

The strategy’s heavy MBS stakes make it an outlier among intermediate core bond category peers; most rivals manage to the Aggregate Index, which features Treasuries, investment-grade corporates, and agency MBS.

The managers actively adjust the fund’s securitized stakes across agency MBS and CMBS. Historically, the portfolio’s combined stakes in these securities have ranged between roughly 65% and 75% of assets (74.7% of assets as of June 2024). Smaller allocations to nonagency MBS (9.7%), CMBS (9.0%), Treasuries (3.8%), and ABS (1.0%) round out the portfolio. Better relative value and a cautious outlook led to a 10-percentage-point increase in its agency MBS stakes and about a 4.5-percentage-point decrease in nonagency RMBS over the past two years. CMBS stakes also fell slightly. The portfolio’s exposure to Treasuries has remained elevated relative to early 2020, when it was only about 1% of assets.

This caution has led to higher exposure to AAA bonds. The June 2024 portfolio had 83.8% allocated to the highest-rated bonds, higher than its long-term average around 80%; AAA bond exposure dominated the portfolio and was about 20 percentage points higher than the category average. To keep up with peers’ yields, the managers prefer to take non-AAA risk within its nonagency securitized bucket.

The managers keep duration in line with the Bloomberg US MBS Index, which subjects the fund to larger shifts in interest-rate sensitivity than most peers experience. For example, as long-term yields rose beginning in 2022, the portfolio’s duration lengthened to 5.9 years as of July 2023 from around 3.0 years two years prior. Over the same period, the 6.2-year peer median duration was nearly unchanged.

The fund’s experienced comanagers Rick Figuly, Andrew Melchiorre, and Michael Sais ably lead the fund. Sais has the longest tenure here (since 2005) but cedes the day-to-day management to Figuly and Melchiorre. Figuly started at J.P. Morgan in 1993 and joined the fund in 2015 when its longtime manager retired; he then rose to became head of the US core bond team in late 2019. MBS specialist Melchiorre is the relative newcomer, joining the fund in 2019, but his industry experience dates to 2008.

Alongside the managers, the firm’s large network of fixed-income specialists helps guide macro positioning and contribute 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, especially for nonagency debt. An eight-person fundamental research cohort, led by Sajjad Hussain since 2021, is responsible for securitized 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.

The managers’ personal ownership, which fosters a better alignment with investors, is solid. Figuly and Melchiorre each invest between $100,001 and $500,000, and Sais more than $1 million.

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.

Over the trailing 10 years, the I shares’ 2.1% annualized return through August 2024 beat its distinct intermediate core median peer’s 1.7% and the Aggregate Index’s 1.6%. These top-decile results were even better when adjusting for volatility. The fund’s Sharpe ratio (a measure of excess return relative to excess standard deviation) ranked in the top decile of the 89 strategies with track records as long. Annualized absolute and risk-adjusted returns over the trailing three- and five-year periods are similarly strong.

The fund’s MBS focus, which results in a higher-quality portfolio than peers, has helped damp volatility. For example, its annualized 10-year 4.1% standard deviation was lower than the peer median and benchmark’s 5.0% and 4.9%, respectively. In market stress periods, the fund consistently holds up better. For example, when corporate bond spreads widened during 2018’s fourth quarter, the fund’s 2.3% gain beat its average peer’s 1.4%. And when long-term yields rose in 2022 amid higher inflation concerns, the strategy’s shorter-duration profile helped limit its loss to 10.1% versus a 13.3% drop for its median rival.

Despite its enviable track record, the fund sometimes behaves differently than most peers. In periods that favor credit risk, the strategy has lagged peers that have larger corporate stakes. And its variable duration profile may not be as an effective a diversifier to risk assets as traditional, longer-duration peers in certain periods.

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 Silver.