JMST: An Interesting Short-Term Muni ETF – JPMorgan Ultra-Short Municipal Income ETF (NYSE:JMST)

JPMorgan’s Ultra-Short Municipal Income ETF (JMST) is a fairly new short-term municipal bond ETF. JMST primarily invests in a diversified portfolio of investment-grade fixed, variable, and floating-rate municipal securities while actively managing credit and duration exposure. This is a review of JMST and a comparison to the primary short-term municipal bond ETF: the iShares Short-Term National Muni Bond ETF (SUB).

JMST seeks to maintain a portfolio duration of less than one year and, currently, has a duration of about 0.62 years. The ETF is designed to provide income that will be exempt from federal taxes and, currently, distributes a 30-day SEC yield of 1.84% or 1.64% unsubsidized.

JMST’s temporary subsidizations and waivers

JMST’s yield is currently subsidized to the effect that JPMorgan is temporarily waiving and reimbursing some expenses. This essentially provides a teaser rate for the young ETF to accumulate assets under management, much like how traditional banks frequently offer a temporarily higher interest rate on the first three to six months new funds. The below image of JMST’s expenses is from the summary prospectus:

JMST’s April 30, 2019, dated monthly fund update for JMST states:

The Fund’s adviser and/or its affiliates have contractually agreed to waive fees and/or reimburse expenses to the extent Total Annual Fund Operating Expenses (excluding acquired fund fees and expenses, dividend and interest expenses related to short sales, interest, taxes, expenses related to litigation and potential litigation and extraordinary expenses) exceed 0.25% of the average daily net assets. This waiver is in effect through 6/30/2019, at which time the adviser and/or its affiliates will determine whether to renew or revise it.

Also, you may have noticed that there are footnotes on the above image. The first one states that the other expenses calculation is based on estimated amounts for the current fiscal year. The second notes:

The Fund’s adviser and/or its affiliates have contractually agreed to waive fees and/or reimburse expenses to the extent Total Annual Fund Operating Expenses (excluding acquired fund fees and expenses other than certain money market fund fees as described below, dividend and interest expenses related to short sales, interest, taxes, expenses related to litigation and potential litigation and extraordinary expenses) exceed 0.18% of the average daily net assets of the Fund. The Fund may invest in one or more money market funds advised by the adviser or its affiliates (affiliated money market funds). The Fund’s adviser has contractually agreed to waive fees and/or reimburse expenses in an amount sufficient to offset the fees and expenses of the affiliated money market funds incurred by the Fund because of the Fund’s investment in such money market funds. These waivers are in effect through 10/31/21, at which time the adviser and/or its affiliates will determine whether to renew or revise them.

JMST’s expenses do appear a little high and it may be the case that JPMorgan decides to continue waiving some fees longer than required. It appears some expense waivers may stop at the end of the second quarter and others through the end of October or shortly after the ETF’s one-year anniversary. It is possible that JPMorgan will further modify their fees, waivers, and operating expense policies on JMST between June and October

JMST’s portfolio

JMST holdings have an average duration of about 0.62 years. The average life and maturity of the ETF’s holdings are similarly short, though the fund does apparently have some paper (1.1%) with as much as four to six years of life remaining. Duration is an exceptionally important characteristic of bonds, as a bond’s duration is a reflection of its sensitivity to changes in interest rates.

(Source: JPMorgan’s JMST info page)

JMST primarily holds investment-grade municipal bonds but not exclusively and also investment-grade is a broad spectrum of various quality. About 70% of the holdings are A rated or higher, but municipal bonds rated BBB or lower are risky here, and especially where the greater credit market may have general issues with leverage on many BBB-rated issuances.

As a result of this mix, JMST’s average credit quality is within the BBB range.

JMST’s primary risks

JMST’s low duration should shield it from most significant debt risk, but the fund is still susceptible to most of the common risks of debt. Below are some of the more serious ones.

Municipal Obligations Risk

The risk of a municipal obligation generally depends on the financial and credit status of the issuer. Changes in a municipality’s financial health may make it difficult for the municipality to make interest and principal payments when due. Under some circumstances, municipal obligations might not pay interest unless the state legislature or municipality authorizes money for that purpose. This could decrease JMST’s income or hurt the ability to preserve capital and liquidity. Municipal obligations may also become susceptible to downgrades or defaults during recessions or similar periods of economic stress.

Credit Risk

Debt investments are subject to the risk that issuers will fail to make payments when due or default completely. If an issuer’s financial condition worsens, the credit quality of the issuer may deteriorate. Credit spreads may increase, which may reduce the market values of the debt securities.

High Yield Securities Risk

JMST may invest in securities that are issued by municipalities that are highly leveraged, less creditworthy, or financially distressed. These investments, known as junk bonds, are considered to be speculative and are subject to a greater risk of loss, greater sensitivity to economic changes, valuation difficulties, and potential illiquidity.

Interest Rate Risk

Interest rate risk is the primary risk for most income funds. When the Federal Reserve was raising interest rates, even with low duration, the fund was facing a heightened level of interest rate risk. Rates appear less likely to continue increasing in the near term or any further increases are likely to occur at a slower rate. JMST has very little interest rate risk.

How JMST Compares to SUB

JMST is an ultra-short-term municipal bond fund that has a medium credit quality portfolio with an extremely short duration. The primary short-term municipal bond ETF is SUB, the iShares Short-Term National Muni Bond ETF. SUB seeks to track the investment results of an index composed of investment-grade U.S. municipal bonds with remaining maturities between one month and five years.

SUB currently has a duration of about 2 years and a 30-day SEC yield of around 1.59 percent or about the same payout as JMST unsubsidized. SUB also has a 0.07% fee, so considerably lower than JMST even with its subsidy. JMST is capable of providing this equal or greater level of income with about one-third the duration by taking considerably greater credit risk. See SUB’s portfolio credit quality below:

(Source: iShares website SUB page)

This results in SUB sporting an average credit rating of AA. Below is a comparison of the above statistics for SUB and JMST.

Essentially, JMST substituted exposure to one risk for another and provided a higher payout at considerably lower duration. It should be very clear that JMST has a considerably greater risk to credit quality and ratings downgrades issues but also that such risk is mitigated by the extraordinarily low duration of the portfolio.

I believe that SUB’s superior total credit profile and fee of just 0.07% make it the better longer term choice, but that JMST is highly competitive and possibly the better option while the fee subsidies are in place. Both could easily find a place in a robust ETF portfolio that is looking for income off with limited interest rate risk.

JMST is likely to reduce the interest rate risk of most income portfolios, where duration is the attribute most likely to get bond investors into trouble. Taking duration to such depths should also make this act nearly like a money market account, and it virtually has for the last several months. See JMST’s performance, below:

Given the reasonable decline in interest rates and average bond yields since December of 2018, we have an example of a somewhat significant move in interest rates and the effect upon this portfolio. Due to JMST’s low duration, it hardly appreciated because bonds that are about to mature are unlikely to recognize much of a premium. If interest rates are to increase, JMST’s portfolio should depreciate roughly equal to or less than that increase.

Conclusion

JMST is a very interesting ETF that really straddles the line between short-term municipal bond funds and muni money market accounts. While the fund is unlikely to substantially depreciate or appreciate in price, the risk associated with the average credit quality makes it unlikely to be a proper core income holding. Nonetheless, it is a strong supplement to cash holdings and bond portfolios that need reduced exposure to interest rate risk by lowering average duration. JPMorgan waived some of JMST’s fees for part of 2019, which makes this fund even more competitive and likely a reasonable allocation up through the end of that subsidization.

Below is a video summary of JMST:

Disclosure: I am/we are long SUB, JMST. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.