JPMorgan International Hedged Equity R5 JIHYX

JPMorgan International Hedged Equity continues to deliver on its promise of a low-volatility portfolio that can help investors stay the course during volatile markets. Consistent implementation by an experienced team and reasonable fees add to its strengths.

The strategy cushions downside loss by forgoing some upside returns. It layers MSCI EAFE Index options on top of an equity portfolio that closely hugs the index on a quarterly basis. To offer downside protection, the managers buy put options with strike prices 5% below the MSCI EAFE Index’s market value. They pay for part of that purchase with proceeds from selling put options 20% out of the money. This structure should generally protect the fund from quarterly losses between 5% and 20%. If markets fall less than 5%, the fund should closely track the MSCI EAFE Index. If the index falls more than 20%, the fund will begin participating in losses once again, maintaining a roughly 15-percentage-point advantage over the index in these quarters. To cover the remaining cost of the put purchase, the managers sell out-of-the-money call options, which limits the strategy’s upside. The call strike price moves dynamically with market conditions, averaging between 3.5% and 5.5% above the index value historically.

Hamilton Reiner runs the show here. The lead manager and architect of the strategy joined J.P. Morgan in 2009 and has more than three decades of equity and options trading experience. He is supported by comanager Piera Elisa Grassi and a deep bench of equity analysts who implement the low-tracking-error equity portfolio the options are built around.

Performance divergence can emerge between this fund and its S&P 500-based counterpart, as each overlay applies to a different index. Nonetheless, the same return pattern holds. As designed, the options overlay has effectively cut risk. The fund contained losses to only 5.3% in the second quarter of 2022 and outpaced the MSCI EAFE Index by over 9 percentage points. The strong downside protection comes at cost, but the fund still provides robust returns. From its 2019 inception through August 2024, the institutional share class returned 5% compared with the MSCI EAFE Index’s 7.9% return. This is a decent option for investors seeking to manage risk in global markets.

The fund earns an Above Average Process rating.

The fund’s option overlay narrows its outcomes and provides a smoother path to equity returns. On top of an equity portfolio that resembles the MSCI EAFE Index, the fund overlays three-month index options that limit downside at the expense of upside. The team purchases 5% out-of-the-money put options and sells 20% out-of-the-money put options on the MSCI EAFE Index. This structure, called a put spread, protects against quarterly index losses from 5% to 20%. The put spread is cheaper than buying the 5% out-of-the-money put outright, but it saddles investors with index losses beyond 20%.

The manager also sells out-of-the-money call options to cover the price of the put spread so that the full options sleeve does not incur a cost. The strike prices on the call options average around 3.5%-5.5% above the index value depending on the net cost of the put spread. This determines the strategy’s upside cap for the quarter. High volatility and interest rates push options prices up, increasing the calls’ strike prices and the fund’s upside exposure.

The team intends to generate a small level of alpha in the equity portfolio by slightly overweighting attractively priced stocks and underweighting expensive stocks based on fundamental analysis. Since the constitution of the equity portfolio closely resembles the MSCI EAFE Index, the index options remain a representative hedge.

The strategy’s equity portfolio should track the MSCI EAFE Index closely as it targets a 2% annual tracking error. Individual stock exposure can also deviate only within a 75-basis-point range. J.P. Morgan equity analysts forecast earnings for each eligible stock using a dividend discount model, incorporating company-specific growth catalysts. The equity sleeve leverages these forecasts to offer marginal improvement over the MSCI EAFE Index within its constraints. The resulting portfolio is well-diversified with around 200 stocks. Sector weightings typically resemble those of the MSCI EAFE with marginal deviation within a percentage point.

The team constructs a zero-cost option overlay and resets it every quarter. In late 2022, it switched to newly available MSCI EAFE Index options that start and end at the beginning of each calendar quarter, instead of those expiring on the third Friday of the last month. This aligns the outcome period with the calendar quarter period.

Call options fetch a higher premium when implied volatility and interest rates are higher, which improved the strategy’s upside in the recent market environment. The strategy can enjoy call strike prices up to 7% out of the money in periods of heightened volatility, as was the case in 2022. In recent calmer months, the upside cap has remained around 6%-7% thanks to high interest rates and demand for call options. In periods of serious market stress where the index drops more than 20%, its short out-of-the-money put will expose the fund to additional losses. It should lose about 15 percentage points less than the MSCI EAFE Index during these quarters, but it is not completely insulated.

Investors should also note that intraperiod performance will vary given that option pricing is dynamic until expiration. Options’ values are marked to market daily, which often results in deviations from the three-month return.

Industry veterans head up the small team managing this strategy. Lead portfolio manager and strategy architect Hamilton Reiner joined the firm in 2009 and has three decades of experience in derivatives markets. Prior to joining J.P. Morgan, Reiner held senior positions across Wall Street at Barclays Capital, Lehman Brothers, and Deutsche Bank. His recent promotion to CIO of the US Core Equity team adds supervisory responsibilities, but this should not affect the strategy’s systematic process. Two junior portfolio managers help Reiner implement the options overlay and act as his backup. The managers also leverage a deep bench of operational resources and the institutional risk framework at J.P. Morgan.

Piera Elisa Grassi, Winnie Cheung, and Nicholas Farserotu are responsible for the international equity portfolio implementation. The equity management team has stabilized since the departure of Demetris Georghiou in 2020. Grassi draws on J.P. Morgan's broad team of global equity analysts, who average about two decades of industry experience, for this equity sleeve and J.P. Morgan’s Global and International Research Enhanced Index strategies.

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.

As a result, its total return has lagged peers as its underlying portfolio of international stocks trailed the performance of US stocks in recent years. The institutional share class trailed the category average by 2.4 percentage points from its 2019 inception through August 2024.

Nonetheless, this fund still provided downside protection for investors looking for a smoother return profile in international stocks. This strategy shines relative to its underlying index when markets perform poorly. The institutional share class lost 13% during the first quarter of 2020, outpacing the MSCI EAFE Index by more than 9 percentage points. During the second quarter of 2022, its drawdown was 10 percentage points shallower than the MSCI EAFE Index. From its 2019 inception through August 2024, the fund’s 10% standard deviation of monthly returns stood out against the index’s 17%.

Prioritizing downside over upside does not mean the fund completely missed out on recent market rallies. It captured nearly 60% of the MSCI EAFE Index’s upside over the past five years, and limited downside capture to the same extent.

Investors should note that intraquarter performance will vary given that option pricing is dynamic until expiration. Options’ values are marked to market daily, which often results in deviations from the options’ values at expiration.

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.