This month, Bond Fund Intelligence again talks again with J.P. Morgan Asset Management Managing Director & Portfolio Manager Dave Martucci. (See too our March 2015 article "JPM's Martucci & Rehman: Defining Conservative Ultra Short.") Martucci oversees over $65 billion in separately managed accounts and conservative ultra-short funds. We discuss the state of the ultra-short market, the Managed Reserves strategy, and a number of issues in the bond space. Our Q&A follows. (Note: This "profile" is reprinted from the August issue of BFI. Contact us if you'd like to see the full issue or if you'd like to see our new Bond Fund Portfolio Holdings "beta" product.)
BFI: Tell us about your history. Martucci: Here at J.P. Morgan Asset Management, we've been managing liquidity or ultra-short type investments for over 30 years. I've been in the business for 17 years, managing ultra-short all the way out to intermediate-type funds. But over the past 10 years, I've really focused on the ultra-short space. Our current offering in the ultra-short space is what we have branded, the Managed Reserves product.
The Managed Reserves Strategy is ... made up of 155 different entities that we manage money for, including four conservative ultra-short funds. We also manage an ETF called the JP Morgan Ultra-Short Income ETF that was launched in May 2017. All of the funds are co-mingled vehicles, which total $12.8 billion, and another $50+ billion is from separately managed accounts.
BFI: What are the funds? Martucci: The ‘JP Morgan Managed Income Fund <b:>`_ is our flagship fund at $9.2 billion and has an inception date of September 30, 2010. We also have two Luxembourg-based funds: JP Morgan Managed Reserves Fund, and the JP Morgan Sterling Managed Reserves Fund; and one Switzerland-based fund. JP Morgan Swiss Managed Reserves Fund. These funds make up $3.6 billion. Of the $65 billion that I mentioned, around roughly $2 billion US dollar equivalent is Sterling and Euro denominated separately managed accounts.
BFI: What are your big challenges? Martucci: The biggest challenge is the flatness of the yield and the credit curves. There's not much yield pickup, and spreads have collapsed on top of each other. There's not much differentiation. So [another] big challenge is to continue to maintain our discipline in here and not stretch for yield by adding too much interest rate or spread duration. [We want to] make sure if we are going to go out and take that additional risk that we're getting compensated for it.
We're still hitting new AUM highs in the Managed Reserves space. A big driver of that has been money market fund reform [money] and clients being better about cash segmentation. But in addition to that, we are starting to see clients move down the yield curve because of the nervousness over the Fed raising rates.... We expect that [gradual move higher] to continue over the foreseeable future. So it's been a nice space to be in, and we continue to expect inflows.
BFI: Compare these with a money fund. Martucci: The most common definition of the ultra-short space is one year and in, in interest rate duration. Other than that, it's pretty wide open. Now what we have done in the Managed Reserves space is listen to our clients, and that has matched up well with our areas of expertise. We've focused on operating in the 'conservative' segment of the ultra-short space. We helped you label that space, which has been very helpful in educating clients. We are not only focusing on interest rate risks, we are also focusing on credit risk at the security level. We also have maximum spread duration of one year across the Managed Income Fund.
In addition to that, we are also taking the best practices that have worked in money market funds. We have an 'approved for purchase list,' so any corporate credit that winds up in our portfolio has to be approved by our credit team, with a specific concentration limit based on the internal rating.... We're buying a lot of the similar bank names that prime money market funds are buying. We're usually just extending out duration in those names, whether it be 6 months to 3 years.... Managed Income Fund has about 60% of its portfolio coming due in one year.... By not having to stay as short as the money market funds, and being able to go down to investment grade or better, we are able to diversify more than a money market fund can. So, typically a money market fund will have anywhere from 80-95 percent in banks, the Managed Income Fund is probably going to have anywhere from 40-60 percent. [T]he rest in industrial paper or non-financial paper. We'll also invest in asset-backed securities as well, so that’s one of the differentiators that we have versus the money market funds.
Since money market reform, we have more and more of the historically large wholesale money market fund issuers coming to us directly. So like you would expect, Canadian, Australian, Japanese, and French banks are coming to us directly or through the Street. This has allowed these issuers to fill some of the funding void from the flight to Government Money Market Funds and has also allowed us to be in the driver seat of many 1-2 year issues from these issuers. This will continue to be an opportunity for ultra short investors.
BFI: What do you do about liquidity? Martucci: For our fund, we typically keep around roughly 5% in true liquidity. Any cash will sweep into the JP Morgan Prime Money Market Fund. The way we come up with the 5% is looking at historical flows, and building in a buffer ... so we're never caught in a situation where we have to be a forced seller in a very short amount of time.... Other places that we will look for liquidity is Treasuries, which are always good to consider in your liquidity bucket. Typically, we're running anywhere from 3 to 5% in Treasuries.... At the moment, the market is very liquid in all the sectors that we're playing in and we're very comfortable with that, and we expect that to continue over the foreseeable future.
BFI: Tell us more about your investors? Martucci: As the fund is getting bigger, we're starting to see a bigger 'bite' size that's more institutional. For instance, over the past few weeks we've had a couple of hundred million dollar inflows, where historically this fund wouldn't be considered for that, and those flows would go to a separately managed account.... I will say though that still a majority of the assets in these funds are more retail-oriented or ultra-high net worth. But we are seeing more traction [as larger] clients become more and more comfortable with the idea of the ultra-short space. We look forward to more success in that area. We are also excited about the launch of the JP Morgan Ultra-Short Income ETF and tapping into the investor base that is looking for an ETF solution.
BFI: What are the risks? Martucci: There is a risk that the Fed starts hiking faster than the market anticipates. If the Fed does surprise ... I think ultra-short is still well positioned. Speaking for the Managed Reserves products, we have roughly 40% in floating rate notes and we have 60% coming due within one year. You have a market [where] the yield curve is very flat, so ... really a faster than expected Fed would lead to steepening out the curve. If anything, that will create a little bit of angst in longer term investors. So you may get some of those investors coming down the curve into the ultra-short space. I think the ultra-short space does look like a sweet spot given the current flat yield curve.
Geopolitically, I think North Korea is front and center right now. We can't ignore that, but I don't think anyone could tell you what the outcome is there.... But in general the global environment is pretty attractive. It's kind of a slow and steady growth. It seems like Europe has turned the corner. It seems like China has stabilized. The U.S. continues to trend along and from the ultra-short perspective is a very attractive environment to invest in. Volatility continues to be at historical lows and at some point that will change. Given the amount of natural maturities in the Managed Reserves product, we would be well positioned to take advantage of any additional volatility.
BFI: What about the future? Martucci: I think the future is definitely still bright, whatever scenario plays out. If it is sharp rise in the rates, I think you’re going to see money come down the curve into the Ultra Short Space. The million dollar question is going to be valuations from a credit perspective, or differentiation. There's not much differentiation across different credits. We have to be aware of that, and I think that plays into J.P. Morgan's hands, again because of our global credit team and the resources we have dedicated to understanding all the credit.... I think at the end of the day, all aspects ... do point to [good things for] the ultra-short space, whether it's clients segmenting their cash to consider the ultra short space or clients coming down the yield curve, flows should continue to be positive in.
