The next iteration in the evolution of Fixed Income ETFs continues apace with the recent launch of JPMorgan’s Global High Yield Corporate Bond Multi-Factor UCITS ETF, complete with ticker JGHY and an annual management fee of 0.35 per cent.
There has been a very positive reaction around this product as it is the first Fixed Income ETF that positions itself in the multi-factor camp. Fixed Income factors, I hear you say, what on earth are those? Well, it’s a long story, but on many levels a simple story at that. To unearth its origins, though, one has to turn the clock back to the 1980s when the Global Financial Crisis of 2008 was a mere twinkle in Michael Milken’s eye.
I suspect even to this day many commentators still do not realise what a huge story High Yield Bonds represent. Looking back, it is quite incredible to contemplate that in the late 1980s Milken was reputedly paid over USD1 billion in compensation over a four-year period while running the High Yield business at Drexel Burnham Lambert. However, in a world where interest rates have never returned to their pre-2008 levels, is it hardly surprising that investors have pursued HY ETFs with a passion, and with that come much lower profit margins.
For all that fervour, why has it taken so long for the ETF community to embrace the idea of factor driven Bond ETFs? On this occasion the reason is somewhat prosaic, the main barrier to entry has simply been the high cost and availability of bond data. Consider it no coincidence that as an increasing percentage of Fixed Income securities trade electronically, there has been a noticeable rise in the number of ‘Strategic Beta’ products.
JP Morgan’s new ETF looks to track the Global High Yield Corporate Bond Multi-Factor Index, a proposition that is built on the back of the notion of only selecting the most attractive looking top 20 per cent HY bonds from an eligible universe of about 3,200. As has become common practice, the proverbial beauty parade ranks the bonds according to their quality, value and momentum score, an investment strategy that I am confident pre-dates the launch of this fund by 20 years.
The index is constructed by starting with the eligible universe and then screening out private and subordinated debt and bonds rated CC and below. The next step ensures that the universe of remaining bonds is aligned to the characteristics of the benchmark from a currency and sector breakdown perspective. The final step ranks the individual bonds on:
- Quality of the issuer: profitability, market leverage & balance sheet ratios
- Value: Market spread vs fundamental value (eg debt to earnings)
- Momentum: Credit and equity price movements
Once these steps are undertaken, the resulting index is comprised of over 80 per cent industrials, barely 10 per cent financials and the remainder in utility bonds.
Call me biased, but one can’t help not being impressed by the stats of the underlying multi-factor benchmark, complete with a 13-year history pre-dating the 2008 crash. A Sharpe ratio of 0.93, an annualised return of 7.8 per cent and a maximum drawdown of 25.7 per cent, all compare favourably to the full HY index. One often hears way too much cynicism from journalists about the perceived marketing hype surrounding Smart Beta ETFs, but on this occasion JP Morgan’s Quantitative Beta Solutions team have done more than enough to silence the critics. Seeded with USD25 million, this ETF stands a very good chance of becoming the go-to product in the Global High Yield space. The starting gun has already been fired for a variation of this product that scores well in the ESG stakes.
For over a decade my own stomping ground was on the ‘Sell’ side, and like so many of the aspiring quants of the world, my bible had been Michael Lewis’s classic ‘Liars Poker’. If ever there was a book that lured so many PhD hopefuls into the arcane world of derivative products, then this was it. Who wouldn’t want to join the quant team on a trading desk in the halcyon days of the 1990s after reading about the antics of the Bond Trading Kings at Salomon Brothers? Presumably all of those Structured Note aficionados who blew up many a trading book and would eventually seek refuge on the ‘Buy’ side.
For those of you new to the world of finance, please be aware that you have to take sides. Buy side, or sell side? Active or Passive? Value investing or momentum investing? Whatever you do, don’t sit on the fence and hold two opinions. After a decade of leaving their mark on the sell side, the army of quants turned their attention to the buy side. If only Michael Lewis had worked for one of the biggest asset management firms, history might have turned out differently.
With the Millennium behind them, it wasn’t long before the stochastic calculus gang turned their firepower to quantitative fund management. With thousands of stocks to select from, surely a powerful computer and some cleverly designed algorithms could detect the patterns that would lead to a winning strategy? Welcome to the world of Smart Beta, or should I say Strategic Beta, to those who are easily offended? Next stop Fixed Income, the trouble being that most firms didn’t have access to or could afford the data.