JPMorgan Hedged Equity 3 R6 JHTRX

JPMorgan Hedged Equity Fund 2 and 3 offer investors a transparent well-defined strategy. Its experienced team and reasonable fees earn the strategy a Morningstar Analyst Rating of Silver for its cheapest share classes, while more-expensive share classes are rated Bronze and Neutral.

JPMorgan launched Hedged Equity Funds 2 and 3 shortly before soft-closing the original Hedged Equity fund in March 2021. They have the same objective of providing smoother returns by tempering downside and upside returns via a systematically implemented options strategy. The newer funds follow the same approach of the original Hedged Equity strategy, however, instead of purchasing options on the last business day of the quarter, Hedged Equity Fund 2 purchases three-month options on the last business day in January, April, July, and October, and Fund 3 trades its options on the last business day of February, May, August, and November. The team purchases put options 5% below the S&P 500’s value. To offset the cost of the put option, the team first sells put options 20% out-of-the-money. This structure should generally protect the fund from three-month losses in the 5%-20% range; if markets fall less than 5%, the fund should fall in line with the market, and if the market falls more than 20%, the fund should incur the same incremental losses beyond negative 5%. The team also sells call options to generate enough option premium income to cover the remaining cost of the hedges.

Hamilton Reiner runs the show here. The lead manager and architect of the strategy joined JPMorgan in 2009 and has more than three decades of equity and options trading experience. He is supported by comanager Raffaele Zingone and 24 JPMorgan equity analysts who implement the low-tracking error equity portfolio the options are built around.

Over the short term, the return profile of Fund 2 and 3 may vary from the original Hedged Equity fund depending on the price path of the S&P 500, but over the long run all three funds should have very similar risk/reward characteristics. Investors looking to make an allocation to this strategy would be wise to pair both Hedged Equity Fund 2 and 3 as this lowers market price path dependency, or the investment’s sensitivity to short periods of market volatility. Reasonable fees coupled with JPMorgan’s transparent process make these funds a strong option to help investors remain invested during challenging markets.

This thoughtfully designed options-trading strategy’s well-defined and disciplined process has produced consistent performance, leading to an Above Average Process rating.

The strategy aims to provide a smoother ride to equity investing by purchasing 5% out-of-the-money put options and selling 20% out-of-the-money put options over a U.S. equity portfolio. This structure, called a put-spread, is designed to protect capital when markets sell off 5%-20% in a given three-month period but also has a lower cost compared with outright put protection. However, since the short option position is so far out-of-the-money, management also sells a call option to cover the price of the long put position. The call options are usually sold 3.5%-5.5% out-of-the-money, depending on the amount of income needed to cover the cost of the long put, but periods of heightened volatility can move that target higher. The level at which the call strikes are written will determine the strategy’s upside cap for the quarter.

The team intends to generate a modest level of alpha in the equity portfolio by being modestly overweight in attractively priced stocks and modestly underweight in expensive stocks based on fundamental analysis. As the constitution of the equity portfolio closely replicates the S&P 500, the use of index options is not problematic from a hedging perspective.

The strategy’s core long equity portfolio should track the S&P 500 closely as it constrains tracking error to 1.5% annually. It aims to outperform that index by tweaking the individual stock exposure within a 1-percentage-point range using a dividend discount model that ranks stocks from most attractive to least attractive based on forecast earnings and company-specific growth catalysts. The team creates a well-diversified portfolio that mitigates risk associated with individual holdings, with the resulting portfolio holding around 200 stocks. Sector weights resemble the S&P 500 with modest underweightings in healthcare and information technology and a small overweighting in consumer discretionary.

The team constructs a zero-cost option overlay that resets every three months. Call premiums received should improve with persistently high market volatility and higher interest rates, thus improving the strategy’s upside in such a market environment. This was the case in much of 2020 (Hedged Equity’s call options had a strike price closer to 7% out-of-the-money following a period of extremely high volatility) and parts of 2021. However, in periods of serious market stress (such as Black Monday in 1987, where the S&P 500 dropped 23% in a single day), the short out-of-the-money put leg of the spread may expose the fund to additional losses.

A small yet experienced management team that leverages JPMorgan’s deep resources earn this strategy an Above Average People rating.

The core team tasked with managing this strategy is small, but concerns about its size are mitigated by the options overlay’s systematic implementation and access to a strong support team. Lead portfolio manager and strategy architect Hamilton Reiner joined the firm in 2009 and now has three decades in the derivatives markets. Prior to joining JPMorgan, Reiner held senior positions across Wall Street at Barclays Capital, Lehman Brothers, and Deutsche Bank, and he spent the first 10 years of his career at O’Connor and Associates, an options specialist firm. Although he is the only dedicated investment resource dedicated to executing the options overlay, there is strong institutional framework at JPMorgan supporting the strategy.

Raffaele Zingone, the other named portfolio manager, joined the firm in 1991 and is responsible for the equity portfolio implementation. He directs JPMorgan's deep bench of 24 equity analysts, who average 21 years of industry experience. Consistent with groups this size, there has been modest turnover on the analyst team. Reiner and Zingone both invest more than $1 million alongside investors, signaling a strong alignment of interest between management and shareholders.

A well-resourced, thoughtful, and disciplined steward of client assets, JPMorgan Asset Management maintains an Above Average Parent rating.

As of 2022, this investment stalwart manages more than USD 2.5 trillion in AUM. Composed of various cohorts globally and a diverse set of asset classes, the firm has more tightly integrated its capabilities in recent years, notably through the development of proprietary analytical and risk systems. Investment teams are robustly staffed and helmed by seasoned contributors. The firm’s strategies tend to produce reliable portfolios, and several flagship offerings are Morningstar Medalists. Manager incentives align with fundholders'; compensation reflects longer-term performance factors, and portfolio managers invest in the firm’s strategies as part of their compensation plans.

The firm’s funds tend to be well-priced, but they aren’t as competitive as many highly regarded peers of similar scale. Recent product launches include thematic and single-country strategies, both of which carry the potential for volatile performance and flows, along with misuse by investors. The firm remains intrepid when it comes to developing an environmental, social, and governance-focused framework and continues to move into other areas such as direct indexing through its 55iP acquisition and China through its joint venture, but these complicated initiatives take time to assess any real and lasting effect.

Newly launched JPMorgan Hedged Equity Fund 2 and 3 should have a similar risk/reward profile to the original Hedged Equity fund over the long run. The options overlay is designed to protect capital when the S&P 500 drops 5%-20% over a three-month period. This means investors will be exposed to losses if the S&P 500 loses less than 5% in that same period. However, investors should expect some short-term deviations between the three funds depending on the price path of the S&P 500, which dictates if the options expire in or out of the money and the upside potential of the fund (based on expected market volatility at the time the options are written).

From their launch at the end of February 2021 through August 2022, the Institutional shares of Funds 2 and 3 have returned 1.95% and negative 2.1%, respectively. The funds have also achieved their goal of lower volatility relative to the S&P 500. The funds had a 10.3% and 10.7% standard deviation, respectively, compared with the S&P 500’s 17.8%.

Investors should note that the intraquarter experience will vary given that option pricing is dynamic until expiration. Options’ values are marked to market daily, which often results in intraquarter deviations from the quarter-end return. For example, the Hedged Equity strategy was down nearly 19% at one point in the first quarter of 2020 but ended the period down 4.9%.

The R6 class charges a low 0.35% per year