JPMorgan Mid Cap Investment Trust (JMF) aims to generate long-term capital growth from investment in a portfolio of UK mid-cap stocks. Managed by Georgina Brittain and Katen Patel, the trust looks to identify structural winners in the mid-cap market and utilises a stylistically blended approach which combines qualitative and quantitative elements.
As we discuss under Portfolio, the managers seek to identify companies with a combination of quality, value and operational momentum characteristics. They believe this approach to be particularly well suited to the mid-cap market, given the lower levels of broker coverage of most stocks potentially giving rise to a greater number of mispriced opportunities or underappreciated growth opportunities. Given the exceptional economic backdrop seen in 2020 thus far, Georgina and Katen have been very much focussed on ensuring JMF remains concentrated in the greatest growth opportunities at this time, in companies which stand to benefit from the ongoing and anticipated operating environment.
JMF is currently trading on a discount of over 14% (as at 25/08/2020). As we discuss under the Performance and Discount sections, this level of discount is wide relative to the trust’s history under the current management team, and previous instances have typically been associated with stronger relative share price and NAV returns than normal.
Although JMF is primarily focussed on generating capital growth, the board has also aimed to increase the dividend in excess of inflation. As we cover in the Dividend section, JMF currently yields c. 3.3% on a historical basis. With substantial revenue reserves, the board should have capacity to grow the dividend in the current financial year even if underlying income is impaired.
Georgina and Katen have demonstrated the ability to add value over the benchmark through stock selection over the long term. Given the current economic situation, the focus on quality and resilience is welcome, whilst the relatively wide discount relative to the trust’s own history gives us a good idea of general sentiment towards the sector. In the short term, we think that relative returns are likely to remain strongly influenced by perceptions of economic performance and future policy support, as well as by company fundamentals.
We think the portfolio’s current tilt towards cyclicality makes sense as a reflection of the relative valuations available, but perceptions that systemic risks are growing and/or of rising insolvency risks could be a headwind to this position in the short term. This is probably true, irrespective of the quality of underlying balance sheets: rock-solid companies in sectors deemed at risk from a weak recovery will likely be hit by any disappointing economic data, irrespective of the impact on their fundamental outlook.
However, for investors willing to look through any short-term volatility, the discount at this level has typically heralded an attractive entry point for UK investors. With a reasonable yield which is well supported by revenue reserves, shareholders can reasonably expect dividends to cushion any short-term share price volatility in total return terms.
|Strong long-term track record||Could struggle if economic risks are perceived to rise|
|Discount at this level has historically represented an attractive entry point||After sizeable shock, may take some time for market to recover risk appetite for mid caps|
|Experienced team with significant analytical resources available to them||Gearing can exacerbate downside as well as amplify upside|
JPMorgan Mid Cap Investment Trust (JMF) aims to generate long-term capital growth through investment in a portfolio of UK mid-caps. As a secondary objective, the board and managers also look to grow the dividend in excess of inflation. JMF is co-managed by Georgina Brittain and Katen Patel, who also co-manage the JPMorgan Smaller Companies Investment Trust (JMI), a UK small-cap OEIC, and the UK portion of a number of European small-cap open-ended funds.
Georgina and Katen are able to draw on the extensive analytical resources available within the wider JPMorgan UK SMID equity team of six specialists. They also utilise extensive external broker research. The managers believe that the small- and mid-cap markets offer structural advantages to equity investors, with companies with greater long-term growth potential and lower levels of broker research creating more opportunities through mispricing.
JMF is an explicitly mid-cap strategy, and as such is benchmarked against the FTSE 250 ex Investment Trusts Index. The managers nonetheless retain the ability to invest up to 15% of JMF’s portfolio outwith the benchmark, allowing them to maintain positions in long-term holdings which may, as a result of their performance, have migrated to the large-cap FTSE 100 Index. Similarly, this offers them the flexibility to hold off-index positions in mid-cap-sized stocks on the FTSE AIM Index, or potentially to introduce very high-conviction small-cap stock opportunities which they believe will highly likely evolve into becoming mid-cap stocks in the reasonably near term.
The managers utilise a mixture of quantitative and qualitative analysis, looking to identify stock opportunities in companies which display a varying confluence of three different characteristics: quality, value and momentum.
Positions are sized based upon stock-specific conviction, with the portfolio primarily constructed upon bottom-up stock analysis. However, Georgina and Katen are cognisant of the wider macroeconomic environment in which companies are operating, and stock analysis will reflect this awareness of broader market and economic conditions.
This stock analysis utilises the quantitative resources available to JPMorgan, combining historic financial statements with consensus expectations. However, the depth of analytical resource available to the managers has proven particularly pertinent given the abnormality of the recent market correction and surrounding economic conditions, and has afforded them the ability to conduct extensive research into the ongoing operational challenges (and opportunities) that portfolio- and index- constituent companies are facing at this time. We have detailed more fully the stock-selection process in our previous research note here.
A combination of bottom-up stock analysis and top-down research which the team had conducted caused them to enter 2020 in a positive mindset, with the expectation of ongoing expansion of domestic UK economic activity fuelling a return of capital flows (and concomitant upwards revaluation) into UK domestic-facing stocks. The exogenous and extraordinary shock of the COVID-19 pandemic and related economic shutdown obviously proved an unexpected headwind to these expectations, disrupting all reasonable expectations of operational models and causing fundamental re-evaluations of the business prospects of myriad companies.
In the initial sell-off and economic slowdown of Q1 2020, Georgina and Katen took steps to prioritise reconsiderations of their existing holdings in the light of the circumstances. They focussed on assessing the balance sheet strength and likely free cash flows under conservative estimates of the likely new environment. These fed into existing considerations about ‘quality’. The process has always sought to identify companies with quality characteristics, but the extreme operating challenges facing the underlying companies made the managers place additional emphasis on these considerations.
Existing management relationships and an ongoing understanding of the operational position of the constituent companies of the stock universe have helped in this regard. This has allowed the managers to understand the relative competitive positions of many companies, as well as the fragility (or otherwise) of supply chains and the resilience of order books against ordinary market conditions. At present, Georgina and Katen are looking to ensure that companies held within JMF are well positioned to continue to emerge as industry winners in the post-crisis world.
As we have previously noted, the team’s approach places emphasis on companies which are industry leaders with the ability to compound long-term returns from effective internal capital allocation. However, the generalised nature of the Q1 2020 sell-off has led Georgina and Katen to focus on the areas they believe offer the greatest upside. This has manifested itself in slightly greater concentration into the highest-conviction positions, as can to an extent be seen in the increased weighting to the top ten holdings compared to when we last reviewed the trust earlier in 2020.
top ten holdings
|As at 31/01/2020
||As at 31/07/2020
|Intermediate Capital Group
||Games Workshop Group
|Games Workshop Group
|JD Sports Fashion
||JD Sports Fashion
||Intermediate Capital Group
||Pets At Home
Source: JPMorgan, as at 31/01/2020 & 31/07/2020
These upside forecasts are currently based upon an assumption of a more normalised operating environment in 2022, with the assumption that the remainder of 2020 and H1 2021 remain ‘write-offs’ for the wider UK corporate sector. On this basis, the team have identified numerous significant value opportunities where the prospects for businesses are, in their view, underappreciated by the wider market at this time.
Many of the existing holdings they had identified as ‘winners’ from the new operating environment have been recognised by the wider market as such following the initial market drawdown. This has included holdings such as Future, a trade publication company with a wide roster of assets under its mantle. Shares in Future have at the time of writing recovered to trade back near to their 2020 high once again, having rallied over 150% from their low in late March.
Within Future’s portfolio, publications such as those providing professional reviews of technology, hardware and software have proven beneficiaries from the increased ‘working from home’ environment. With revenues primarily driven by advertising, increased visits to these websites have had significant benefits to revenue streams. As Future naturally scores highly on Google search algorithms, traffic is fairly natural to these sites and increased spend on promotion has not been necessary to drive increased readership. The stock itself has been the subject of a prominent short-selling campaign, which has highlighted the extensive M&A costs the company has incurred in expanding its footprint. Whilst many of the revenue increases of recent years have indeed been inorganic, Katen noted that this missed the scalable benefits from integration into the Future platform that these acquisitions tend to subsequently enjoy. Furthermore, strong and resilient levels of free cash flow have consistently allowed the company to deleverage following acquisitions in recent years.
Whilst Georgina and Katen felt confident that existing holdings such as Future offered (and continue to offer) very substantial upside in the teeth of the market sell-off in Q1 2020, the managers have in recent weeks and months been rotating away from companies which had performed more strongly in protecting to the downside. This has been conducted less on an expectation that markets will mean revert for the sake of mean reversion, but in recognition that the stronger-performing holdings tended to be more inherently defensive businesses. Accordingly, they now perceive them to have lesser upside potential. Other sales have been conducted in recognition of the changed operating environment.
Although many positions are currently held in recognition of companies’ industry-leading positions and perceived ability to leverage these to take market share in the current challenging conditions, the managers have also identified sectors which enjoy broad operational momentum tailwinds at this time. This includes the wider housebuilding sector. The housebuilding industry is already highly concentrated amongst a few select major players, and there thus seems limited realistic opportunity for further consolidation. However, Georgina and Katen note that they expect the sector as a whole to benefit from moves to increase the rate of housebuilding, potentially further catalysed by reforms to planning laws.
Exposure to this sector includes stocks such as Vistry, which exhibits very strong balance sheet strength. Vistry also displays strong profit margins on existing projects, and even when very conservative assumptions (including sharp falls) are made regarding underlying housing prices and potentially rising input costs, Vistry should still remain profitable on individual housing units. The managers do not believe that this, or the likely top-line growth, is reflected in the current share price.
This further feeds into a general tilting within the portfolio towards cyclicality, relative to JMF’s typical positioning. Areas such as housebuilders are, the managers believe, currently likely to display the strongest potential upside from any economic recovery, whilst many areas likely to be structural winners from the ongoing crisis already see their improved operational positioning reflected in their share price. The focus on the opportunities which the managers believe to currently offer the greatest upside has led to some significant divergences from the benchmark on sector allocations.
JMF currently has net gearing of c. 6.3% as at 31/08/2020 (Source: London Stock Exchange). Gearing is utilised flexibly: the managers will tactically adjust the level of borrowings to reflect the number and extent of stock-specific opportunities they are identifying, and with reference to broader market conditions.
This has been successfully done in certain periods in recent years, including the decision to reduce gearing to around 0% ahead of the Brexit referendum (when UK domestic assets subsequently sold off in the immediate aftermath). Another successful decision was to hold relatively modest gearing levels in the second half of 2018 (from c. 4.6%, gradually reduced to c. 1.1% by the end of the year) as global risk sentiment turned negative.
However, gearing has proven a headwind in the market conditions of 2020, with JMF having entered the year with reasonably high levels of gearing which exacerbated downside during the market sell-off of Q1 2020. With the trust having reasonably full levels of gearing relative to its structural constraints during the sell-off, there was limited scope to increase gearing levels in Q1 2020 as declining NAVs mechanically increased the ratio of gearing. Nonetheless, with significant experience of previous violent sell-offs, the managers opted to maintain gearing levels in anticipation of a recovery, which will have boosted Q2 and Q3 (to date) returns.
The board has specified that it expects gearing to stay within a range of between 5% net cash and 25% geared.
JMF’s returns under Georgina’s tenure have been strong (with Katen joining in April 2014), with NAV and share price returns of c. 144% and c. 153% respectively from 01/04/2012 (the first full month with Georgina as lead manager) to 25/08/2020. This represents significant outperformance of the wider peer group, which has produced average NAV and share price returns of c. 60% and c. 65% respectively. Similarly, a passive product tracking the benchmark FTSE 250 Index would have returned c. 85% over this period.
The mid-cap focus has been a tailwind relative to peers, whilst we think that fairly consistent deployment of gearing is likely to have been a contributor to excess returns above the mid-cap benchmark over this period. However, assuming the benchmark index was consistently geared at 10% over this period, we estimate this would still have returned only c. 95%. This suggests to us that stock-picking and management of gearing levels have contributed significantly over this period.
performance vs peers & benchmark
The challenging market environment of 2020 has impacted 12-month returns, with JMF generating NAV and share price returns of c. -8.7% and -10.5% respectively over the 12 months to 25/08/2020. This represents underperformance relative to the peer group average, which has seen NAV and share price returns of c. -7.2% and -7.5% respectively, and also relative to the benchmark index, which has seen returns of c. -6.8%.
However, under Georgina’s tenure such underperformance over a 12-month timeframe has been relatively uncommon, having only occurred on c. 33% of occasions. Over this period, JMF has a median 12-month relative NAV and share price return relative to the FTSE 250 index of 5.3% and 6.2% respectively. Relative to the FTSE All-Share over all time periods, JMF has averaged relative NAV and share price returns over all rolling 12-month time periods of c. 6.2% and 8.6% respectively (Source: Morningstar).
rolling 12-month nav returns vs peers & indices
The graph above shows the trailing relative returns of JMF’s NAV, so a reading in January 2017 essentially shows the performance over 2016 up until the date of said reading. Underperformance in 2016 was in large part driven by a negative shift in sentiment towards UK domestic assets following the Brexit referendum. Ahead of the referendum results, Georgina and Katen had reduced their exposure to UK domestic revenue generators in recognition of this risk, but on a relative basis the continuation of the declining trend in sterling still hurt performance.
As we discuss under Discount, JMF presently trades on a wide discount to NAV relative to its history under the current managers’ tenure. This level of discount or wider has, over the period under review, typically been associated with strong subsequent returns on a relative basis.
In the table below can be seen the subsequent 12-month NAV and share price relative performance on occasions when the discount has been wider than 11.4% (this representing more than one standard deviation below the median level since 01/04/2012), and also when it has been wider than 14.4% (the current level). This has occurred on c. 37% of occasions in the period 01/04/2012–26/08/2020. This level of discount has tended to be associated with a strong period for subsequent returns relative to both the FTSE 250 and FTSE All-Share.
subsequent 12-month nav and share price relative returns when the discount has been wider than 11.4% and 14.4%
|discount wider than 14.4%||discount wider than 11.4%|
|Relative to FTSE 250||Relative to FTSE All-Share||Relative to FTSE 250||Relative to FTSE All-Share|
JMF shares currently yield c. 3.3% (as at 26/08/2020) on a historic basis. The managers focus on generating capital growth, and as such dividend distributions are a secondary consideration that arise as a consequence (as opposed to a target) of the investment process.
Although the investment managers regard income generation as a by-product of the stock-selection process as opposed to a goal, the board of JMF has typically sought to increase distributions by at least the rate of inflation. To the end of the financial year (FY) 2019 this has been comfortably achieved, with an annualised growth rate over this period of c. 10.4% p.a., whilst the CPI has increased by c. 2.3% p.a. over the same period (Source: Morningstar, JPMorgan).
Dividends are paid twice a year. The FY 2020 interim dividend of 8p per share was in line with the FY 2019 interim dividend. A final dividend has yet to be declared. Whilst clearly underlying income generation is likely to face challenges from the difficult operating environment companies find themselves in, Georgina and Katen observe that the companies held within JMF have generally proven relatively resilient and indeed in many instances are starting to beat expectations operationally, as we have noted under Portfolio.
With the FY 2019 dividend very well covered by income, a full-year income impairment of up to c. 15% could be incurred whilst still leaving a maintained FY 2020 dividend covered. Although market-wide impairments are estimated to be significantly higher than this in 2020, the financial-year period for JMF includes H2 2019, and thus this is likely not feasible.
Should a maintained dividend not be covered by income, however, the board has recourse to significant revenue reserves to support this. In recent years the board has repeatedly opted to distribute only around 85% of income received, using the surplus to boost the revenue reserve.
As a result, JMF had revenue reserves equating to c. 1.87x the FY 2019 dividend as at 31/12/2019. Subsequently, an interim dividend of 8p per share has been paid. Even if no income has been collected in the period since 31/12/2019, and this interim dividend was paid solely out of revenue reserves, we estimate revenue reserve cover remains at around 1.6x the FY 2019 dividend. Accordingly, the board would seem to have ample scope to support the dividend going forward should it so choose.
dividends per share
JMF is managed by Georgina Brittain and Katen Patel. Georgina has worked for JPMorgan Asset Management since 1995 and began managing JPMorgan Smaller Companies Investment Trust in 1998; companies often migrate between these strategies as they move up the market-cap spectrum. Georgina also manages onshore and offshore open-ended small-cap funds. She was appointed as manager of JPMorgan Mid Cap in March 2012 and was joined by Katen Patel on the trust in April 2014. He works with Georgina on the open- and closed-ended smaller companies funds and has also managed the all-cap JPMorgan UK Equity Income Fund since it was launched in May 2017. Katen spent seven years on the sell side before joining JPMorgan in 2013.
JPMorgan Mid Cap currently trades on a discount of c. 14.4% (as at 26/08/2020). Reflecting the negative attitude towards risk assets in general and UK equities in particular, this is substantially wider than JMF’s five-year median discount level of c. 7.5%; indeed, this is not far short of two standard deviations below the five-year median level.
Georgina was named manager of JMF in March 2012. Over this time period, JMF has traded on a wider discount than the current 14.4% level on c. 14.2% of daily readings. With the nominative association and its explicitly mid-cap bias, it would not be unreasonable to assume the discount on JMF will often be reflective of wider sentiment towards the UK mid-cap market (and domestic economy). As we discuss in the Performance section, subsequent NAV and share price returns have tended to be strong when the discount is at its present levels.
However, this requires an assumption of a similar operating environment going forward. This is by no means assured, given the extraordinary market and economic conditions we currently find ourselves in. However, the UK market has experienced numerous disruptions over this period. The level of discount on JMF, setting aside any look-through valuation opportunity in the underlying assets, would seem indicative of a general risk aversion in UK market allocations.
The shareholder register remains highly diversified, with only three notifiable shareholding interests, who we estimate have cumulative holdings of c. 14.8% of shares outstanding. In June 2019, JMF changed its corporate broker in an effort to improvement shareholder engagement and support the trust’s market efforts, with the implicit intention of helping to narrow the discount over the longer term.
The board has the ability to repurchase shares to help address any imbalances between supply and demand for shares in the market. In the current financial year (from 30/06/2020), the board has not yet exercised this ability. In the previous financial year (to 30/06/2020), the board repurchased 6,321 shares at a discount of c. 8.5%. JMF currently holds c. 1.7m shares in treasury (equivalent to c. 6.6% of the total shares in issuance); the board has committed to only re-issuing these to the market should the trust trade at a premium to NAV.
JMF has an OCF of 0.87%, slightly above the average of the AIC UK All Companies sector of 0.61%; this is in part a reflection of the relatively smaller size of assets. The OCF is inclusive of the management fee of 0.65% of the first £250m of net assets and 0.6% thereafter; with assets currently at c. £274m, this represents a weighted management fee of c. 0.65%. There is no performance fee. The KID RIY figure is 1.27%, slightly above the sector average of 1.17%; this is likely representative of the above-average turnover ratio within the portfolio, with associated costs. We would caution that calculation methodologies vary.
JMF is managed by JPMorgan Asset Management (JPMAM). JPMAM is a signatory to the United Nations’ Principles for Responsible Investment and therefore is committed to the six principles encased therein, which aim to incorporate ESG criteria into investment processes and to promote ESG disclosure.
ESG issues are now incorporated at every stage along the decision-making process, including quantitative and fundamental analysis. This is primarily achieved through a number of third-party sources, eventually giving each prospective company an absolute score for ESG.
The team are able to draw on ESG specialists within the wider JPMAM team who are tasked with ongoing assessments on how companies deal with ESG risks and issues. This utilises a ‘red flags’ model where each company’s corporate governance, forensic accounting and financial distress are assessed. In the future, the managers envisage all the research coming from in-house; however, this is still being developed.
Further supporting the ESG aspects of the process, Katen was in 2019 named manager of a pan-European ESG fund. Some of the output from this is expected to filter down to the JMF portfolio as Katen gains greater insights into the area.