J.P. Morgan Asset Management’s Bryon Lake on using ETFs as an asset allocation “tool” and why clients prefer solutions not products
Focus is a publication that aims to bring you face-to-face with a selection of key investment managers, advisers and providers from across the institutional pensions market. ETFs can be effective tools for implementing a variety of strategic and tactical portfolio strategies. In fact more and more schemes are using them as an asset allocation “tool” in an effort to provide clients with “solutions” rather than simply “products”. So it is often a misconception that ETF equals Passive, says Bryon Lake, Managing Director and Head of International ETFs at J.P. Morgan Asset Management. In this guide Lake shares how he uses ETFs to provide a range of powerful investment strategies that are precision built to help schemes and their clients navigate evolving markets and ultimately build stronger portfolios.
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ETFs are now offered on virtually every asset class ranging from traditional investments to alternative assets like commodities, currencies, managed futures and even equity long short. And the institutional market for them is growing.
‘Active’ ETFs: The rise of exchange traded funds in Europe
Bryon Lake, Head of International ETFs, J.P. Morgan Asset Management
According to a Greenwich Associates report published in 2017 (“ETFs: Dynamic Tools for Institutional Portfolios”) 45% of institutional ETF investors were using ETFs for liquidity management, up from 36% in 2015. One of the recent innovations to the market is actively-managed ETFs. Instead of being index-based or following smart beta rules, a portfolio manager has discretion to adjust the active ETF portfolio as desired. The best of both worlds? We spoke to Bryon Lake, Head of International ETFs at J.P. Morgan Asset Management, about how he is utilising the firm’s scale in the active space to launch ETF products into the European market covering all asset classes.
*Source: Citi, October 2018.
First, it’s important to note that we start with the ETF wrapper: a benefit-rich vehicle which offers investors a number of conveniences. Ultimately we think about the ETF as a wrapper – a technology – and that wrapper comes with a lot of benefits. It trades throughout the day and it’s often transparent so you get good price discovery. What’s more most asset class can be delivered through an ETF. So for example, some of our strategies are actually active strategies run by a portfolio manager and delivered through the ETF wrapper. We also have smart beta capabilities, such as our JPM USD Emerging Markets Sovereign Bond Fund ETF (JPMB). Unlike some of the other emerging markets bond indices out there, we screen securities for liquidity and by duration times spread, which essentially helps to eliminate potential falling knives within the portfolio. Then we reorient the portfolio back towards a higher yield, which is what investors are looking for from the emerging market bond space. So there are several innovative areas we see delivering both active and smart beta strategies through the benefit-rich ETF wrapper.
What is driving the uptake of active ETFs and what are the benefits to schemes?
Part of the appeal of ETFs is that they can be used in a variety of ways: for example, as the foundation of a portfolio, or to implement more tactical and sometimes very specific ideas. With our wide ranging capabilities we are able to deliver, via the ETF wrapper, our proprietary investment capabilities helping institutional investors build more precise portfolios. When we moved into the ETF space it was the case of building out our ETF platform to deliver some of our core capabilities rather than changing our overall strategy. As a very established player in the institutional market we are now able to offer institutional investors our strategies through the ETF wrapper. We observed that many of our institutional clients were embracing the ETF vehicle and so we are building out our ability to deliver our capabilities through the ETF wrapper to help meet these evolving client needs.
Why did you decide to launch your ETF business in Europe?
In the last decade new regulation has reduced the ability of investment banks to hold bond inventory. Fixed income ETFs have played a role in bridging that gap, providing inventory to the market and allowing secondary market liquidity. The flexibility, diversification and the potential for tight spreads that fixed income ETFs provide are the main reasons we’re seeing pension schemes adopt them. You get the benefits of the wrapper, which give you the look and feel of an individual security like a stock, but equally you can get fixed income exposure through it as well. They are rapidly being adopted by investors and pension schemes because they appreciate the transparency the ETF wrapper provides. It allows them to precisely define what types of exposure they’re getting, because pension schemes tend to be big asset allocators and they have a top-down perspective. The more precise and transparent the strategy is, the more accurately they can reflect and execute their vision of the market.
You’ve been quick to develop a range of fixed income ETFs. In what ways are fixed income ETFs attractive to pension schemes?
Delivering J.P. Morgan’s expertise through the ETF wrapper provides added value for our clients, whereas most of our competitors tend to licence indexes in order to deliver exposure to the wrapper. We’re already quite differentiated via our own proprietary strategies so that’s a benefit pension schemes receive when working with us. Another benefit is the manager access we provide: our investment professionals are on hand to ensure schemes understand exactly what they are investing in. As a business, we see this as a fiduciary responsibility. It’s also part of our broader strategy. For example, when we launched our emerging market bond ETF based on an index, it was designed with the wrapper in mind. Pension funds are aware of the risks associated with emerging market bonds; so to see the exposure and the capabilities we have has been a differentiating factor. Ultimately, our move into this space means that our clients can access cost effective ETFs and at the same time receive the value-added service you would expect from a large asset manager. Whether it’s our thorough research, the technology that drives this, the robustness of our platform or the capabilities of the people that we have, we think schemes benefit from this all-in-one package.
Why would a scheme choose J.P. Morgan ETFs; what are the benefits to a pension fund’s portfolio?
It’s our view that the ETF market, both globally and regionally in Europe, could double over the next five years and that’s also the view of many market commentators. To tap into this growth, we want to build a robust ETF platform that helps our clients achieve their outcomes. We want to deliver the types of strategies that investors are looking to use in their portfolio and we want to have the right people in place to support our pension clients and other investors, so that they are aware of our different solutions and capabilities. If we do all of those things, then we’ll define it as a success and everything else should really take care of itself.
How will you seek to maintain the growth of your ETF offering?
In this capacity, Bryon is responsible for leading JPMAM’s International ETF business with a particular focus on Europe and Asia. Bryon is based in London and is one of the industry’s most respected and accomplished ETF executives. As one of PowerShares earliest employees, he held various leadership positions within the firm as it advanced from an independent start-up to becoming the fourth-largest ETF provider globally, with more than $100 billion in assets under management as part of Invesco. Most recently, he was Head of Invesco PowerShares EMEA, where he led the firm’s efforts to expand its EMEA team, evolve its portfolio set and maximise growth opportunities. During his 12-year tenure with the firm he also served as Head of Global Business Development and was one of the company’s top sales people. Bryon graduated from Taylor University with a Major in International Business and Minors in Finance and Economics.
Bryon Lake, Head of International ETFs at J.P. Morgan Asset Management (JPMAM)
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JPM USD Emerging Markets Sovereign Bond UCITS ETF
This strategy (ticker: JPMB) provides exposure to the return and yield potential of the rapidly expanding emerging market debt sector, while enhancing liquidity and improving country and credit risk allocations relative to traditional market cap-weighted benchmarks. Investing in emerging market debt through a traditional index fund is challenging, as market-cap-weighted benchmarks suffer from unrewarded credit risk concentrations, poor liquidity and fluctuations in duration. In contrast, JPMB uses a disciplined, optimisation-based investment approach to minimise tracking error vs. the JPM Emerging Market Risk-Aware Bond Index—an innovative benchmark that employs a powerful three-step screening process to provide risk-managed exposure to the yield and return potential of emerging market debt.
Meet the managers
Eric Isenberg, portfolio manager
Naveen Kumar, portfolio manager
Niels Schuehle, portfolio manager
JPM USD Emerging Markets Sovereign Bond UCITS ETF
Strategies: Diversified growth
Step 1: A liquidity filter ensures the fund’s starting universe is liquid and investable. Instruments are filtered based on face amount outstanding and maturity.
Step 2: A risk screen removes exposure to countries with the highest level of relative risk. Countries are ranked according to their relative risk level, with the lowest 10% of market cap by risk removed.
Step 3: Credit stabilisation provides more consistent access to emerging market credit risk. Index is reweighted to maintain a consistent risk contribution of 75% high yield/25% investment grade.
Emerging market debt is a growing component of global bond markets
Source: J.P. Morgan Asset Management; Bank for International Settlements. Guide to the Markets – U.S. Data are as of 31 December 2018.
17 years of industry experience, two at J.P. Morgan Head of Fixed Income Portfolio Management for Quantitative Beta Strategies at J.P. Morgan Asset Management. In this role, Eric is responsible for portfolio management of all passive fixed income funds, including index replication and smart beta fixed income funds.
Seven years of industry experience, all at J.P. Morgan Head of Fixed Income Research for Quantitative Beta Strategies, based in New York, focused on further developing the Firm’s factor-based franchise in fixed income.
Eight years of industry experience, two at J.P. Morgan Portfolio manager in the Quantitative Beta Strategies group, based in London.He previously worked for the Global Head of Strategic Product Management from and on the J.P. Morgan Private Bank Manager Selection Team specializing in equities.
BUILDING A RISK-AWARE BOND INDEX
The above target risk/return are the investment manager’s internal guidelines only. There is no guarantee that these objectives will be met.
Investment approachThis strategy (ticker: JPST or JMBE for EUR Hedged) is actively managed to deliver a current income while managing risk by investing in a diversified basket of short-term, investment-grade fixed and floating-rate corporate and structured debt. The strategy benefits from the extensive resources, proprietary credit research and continuous risk management oversight of J.P. Morgan Asset Management’s respected Global Liquidity platform. Securities are selected from a conservative internally-approved list, which is based on the credit ratings generated by a team of 20 specialist sector analysts. The portfolio is constructed within a highly risk-controlled framework, targeting an ultra-short duration range (typically 0.25-1.00 years). Thanks to its conservative philosophy and the low cost daily liquidity provided by the ETF wrapper, the strategy can help cash investors enhance the yield on their reserve cash allocations within segmented cash portfolios. The strategy can also help fixed income investors reduce credit and duration exposure in longer-term strategic short duration portfolios while maintaining a steady and predictable income. JPST is part of an Ultra-Short solutions suite with JGST the sterling option and JEST a Euro version also available.
JPM USD Ultra-Short Income UCITS ETF
Strategies: Flexible credit
J.P. MORGAN’S GLOBAL LIQUIDITY INVESTMENT PROCESS
*Asset-Backed Securities, Commercial Mortgage-Backed Securities, Retail Mortgage-Backed Securities, Collateralized Loan Obligations. Source: J.P. Morgan Asset Management.
Meet the managers
James McNerny, portfolio manager
18 years of industry experience, all at J.P. Morgan Portfolio manager within the Global Liquidity business. James oversees managed reserves portfolios. An employee since 2000, James has previously served as a fixed income portfolio manager and product specialist in both London and New York, focusing on liquidity, short duration, broad market, extended market and total return products.
David Martucci, portfolio manager
18 years of industry experience, all at J.P. Morgan Global head of the Managed Reserves team and a portfolio manager within the Global Liquidity business.
Kyongsoo Noh, portfolio manager
18 years of industry experience, 17 at J.P. Morgan Portfolio manager within J.P. Morgan’s Global Liquidity business and oversees managed reserves portfolios. Prior to this role, Kyongsoo was an ABS portfolio manager within the U.S. Fixed Income Group.
Cecilia Junker, portfolio manager
31 years of industry experience, all at J.P. Morgan Portfolio manager within the Global Liquidity business. In this role, she oversees managed reserves portfolios. Previously, Cecilia served as a portfolio manager within the U.S. Fixed Income Group, specialising in asset-backed and commercial mortgage-backed securities.
THE CASH SOLUTIONS SPECTRUM
*Indicates duration target range. Source: J.P. Morgan Asset Management.
Integrating ETFs: Opportunities and challenges
need to know
As new investor segments continue to integrate ETFs into their portfolios, we asked Hortense Bioy, Director of Passive Strategies and Sustainability Research at Morningstar, what she sees as the benefits and barriers to entry of the ETF wrapper
The beauty of ETFs is that they offer low-cost and liquid access to a diversified basket of securities. Another hallmark is their flexibility. By virtue of trading on a stock exchange like common shares, ETFs can be traded intraday. You don’t have to make use of this feature but it is good to know that at any moment you can buy or sell your fund. This trading flexibility also means you can short ETFs and implement a hedging strategy. What’s more, there are futures and options available on ETFs which again shows the flexibility of the wrapper relative to traditional funds. ETFs can also improve diversification by providing exposure to different asset classes, sectors, geographies and so on. They are a good way to manage a whole host of different risks that may exist within a portfolio. You can use them for strategic asset allocation by establishing low-cost core building blocks. And they can be used tactically by overweighting the asset class when it represents good value. In the case of physical ETFs, you can see the holdings contained within; and in the case of synthetic ETFs, there is transparency on collateral. You won’t find the same level of transparency in any other investment vehicles. ETFs also have a tax advantage in the US because of the creation-redemption mechanism which is a unique feature of ETFs. ETFs are very democratic by nature. By virtue of being listed on the stock exchange, anyone can buy ETFs.
What are the benefits of investing in an ETF?
Pension funds particularly like the flexibility of ETFs as it allows them to gain tactical exposure to a specific market at a very low cost. They can also use ETFs for cash equitisation purposes and transition management. Breadth of choice is another reason for pension funds to invest in ETFs. Innovation in ETFs has been relentless and now fund managers can gain exposure to a wide range of asset classes and strategies through the ETF wrapper. Liquidity issues in the bond market have led many institutional investors, including pension funds, to consider bond ETFs as a suitable alternative for single bonds.
Why would a pension fund invest in ETFs?
Education remains a key factor in the adoption of ETFs. Pension funds may be sophisticated investors but they still need to be educated about the quirks and peculiarities of ETFs. Liquidity and the creation and redemption mechanism are among the main features of the ETF vehicle that they need to understand. Also, pension funds have access to other types of investments, some of which may be cheaper or can be tailored to their specific needs. Plus, ETFs don’t always have a good press and some investors may be reluctant to use them.
What are the barriers to entry?
The macro environment is not easy to navigate and in the coming months investors will have to find ways to diversify and protect their portfolio from market volatility. In that context, alternative ETFs can be a nice addition to the palette of products available in the market, focusing on the liquidity aspects offered by the ETF wrapper. Fixed income ETFs, either passive, smart beta or active, are still in their infancy. The offer is rapidly growing and we think they will play an important role in the growth of the ETF market overall. Fixed income AUM has grown at a rate of over 26% over the last five years and we think this will continue, or even accelerate, over the next five to ten years. At J.P. Morgan, we are building out a strong ETF business which leverages the best of our active, smart beta and plain vanilla capabilities to serve different client needs over the next three to five years. We are doing this because sophisticated investors across Europe have told us they want to see innovation across a range of asset classes. What’s more, these investors are on the lookout for strategies that can provide diversification benefits in their portfolios. The ETF wrapper, and the liquidity it delivers, is providing a suitable answer to this need.
The diversification benefits of ETFs
Investors are on the lookout for strategies that can provide diversification benefits in their portfolios. The ETF wrapper can help, writes Olivier Paquier, Head of Continental Europe ETF Distribution at J.P. Morgan Asset Management.
BUILDING STRONGER PORTFOLIOS
At J.P. Morgan Asset Management, collaborating with our clients in an effort to build stronger portfolios drives everything that we do. We are commited to sharing our expertise, insights and solutions across all asset classes to help make better investment decisions. Whatever you are looking to achieve, together we can solve it.
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