JPMorgan Mid Cap (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 have detailed in the Portfolio section, the managers seek to identify companies with a mixture of quality, value and momentum factors, and believe this approach is well suited to a mid-cap market where broker coverage is lower than in the large-cap market (and thus there are more opportunities to identify unappreciated growth and/or mispricing opportunities).
Performance has been very strong over the past 12 months, with NAV returns significantly outstripping the benchmark index. The wider market seems to have recognised this, with the discount narrowing over this period to its present level of c. 2.7% (as of 14/02/2020), helping to ensure share-price returns were very strong over this period.
Whilst the primary aim of JMF is to generate capital growth, the managers and board also aim to see the dividend rise in excess of inflation every year. This has been comfortably achieved in recent years, allowing the board to increase distributions at a rate substantially above inflation whilst simultaneously accumulating further revenue reserves, as we cover in the Dividend section. JMF presently yields c. 2.1%.
As a result of the managers’ positive outlook for the UK mid-cap market, gearing has been increased and now stands at c. 9%. This reflects the variety of opportunities they continue to identify.
JMF has a disciplined and repeatable investment process with demonstrable success in the mid-cap market. The closed-ended structure and the attendant ability to utilise gearing are positives for investors looking to access the UK mid-cap market, as it should help ensure upside market capture remains strong, although admittedly presenting a headwind on occasions of market stress.
Recent months (at the time of writing) have seen strong returns, but (as the managers have themselves highlighted) there remains long-term valuation potential in UK domestic assets which could continue to drive outperformance over the medium term. Furthermore, the JMF portfolio on a look-through basis has a higher free-cash-flow yield, higher returns on equity, and stronger operational momentum than the index, which should reasonably be expected to ultimately be reflected in stronger returns.
Historically, the volatility of the discount has been high relative to AIC UK All Companies peers. One possible reason is investors using the trust to quickly adjust their exposure to UK mid-caps UK mid-caps as they go “risk-on” or “risk-off”. The present level of discount is trading near par, and further narrowing should not reasonably be expected; however, in the past when the discount has moved wider than the peer group it has often represented an attractive entry point. Ample revenue reserves should continue to support a reasonable dividend yield and continued growth of distribution in real terms.
|Has exhibited significant and consistent outperformance||Discount has narrowed substantially and is trading near par|
|Disciplined process aided by robust quantitative framework||Gearing can exacerbate the downside (as well as amplify the upside)|
|Experienced team with significant depth of analytical resources||Short-term political noise could remain a headwind to UK domestic assets in particular|
JPMorgan Mid Cap (JMF) aims to generate long-term capital growth through investment in a portfolio of UK mid-cap stocks. As a secondary objective, the board and managers also look to grow the dividend in excess of inflation. JMF is 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 made up 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 create more opportunities through mispricing.
Utilising a mixture of quantitative and qualitative analysis, the managers seek to identify companies which incorporate varying degrees of three characteristics: quality, value and momentum.
JMF is a mid-cap strategy, benchmarked against the FTSE 250 ex Investment Trusts Index; however, the managers have latitude to invest up to 15% of the trust outside the benchmark. This allows them to maintain positions in long-term holdings such as JD Sports which may have, as a result of their success, moved into the large-cap index. It also offers them the ability to hold mid-sized stocks on the AIM Index, if they deem it appropriate.
The portfolio is constructed based upon the team’s bottom-up stock analysis, with positions holding a confluence of the value, quality and momentum factors and generally sized on conviction. Positions are generally introduced at levels between 0.5% and 1% in excess of the benchmark weighting and expanded as and when each business’s operational performance validates the initial investment thesis.
Georgina and Katen have latitude to take active positions up to around 5% overweight, but may hold greater active positions than this if this is a result of stock outperformance. As well as operational momentum within the underlying businesses, the managers are cognisant of share price momentum within their portfolio which often arises from market recognition of improving fundamentals; they are generally happy to run their winners in this regard, but will top-slice their position if they deem a single stock to be contributing too great a level of portfolio risk.
Top ten holdings
||portfolio Weighting (%)
|Intermediate Capital Group
|Games Workshop Group
|JD Sports Fashion
Source: JPMorgan Asset Management, as at 31/01/2020
The quantitative system inputs both historic numbers and consensus expectations for future data (such as earnings or sales growth), inputting expectations from brokers covering a stock as well as the company’s own annual reports. The quantitative system serves to highlight potential investment ideas, which operate as a precursor to further qualitative assessment.
Qualitative stock analysis within this investment process will seek to develop the team’s understanding of, in the first instance, the quality of the company. This will include measurable metrics from the quantitative screen (such as profit margins relative to the sector), but also requires a qualitative assessment of other, less tangible factors. The team will seek to understand the underlying business model and its relative strengths, looking at factors such as capital-allocation discipline and returns on capital, competitive advantages, and the sustainability of earnings.
In doing so the team are seeking to provide context for historic numbers and data, and looking to understand historical trends in profits and how capital-allocation decisions by management have impacted them. Sustainability of earnings is considered important, especially as the managers have a preference for ‘running their winners’. Accordingly, as well as setting historic numbers in context, Georgina and Katen are seeking to understand ongoing company-specific and industry dynamics and how these may impact future operations, including from an environmental, social and corporate governance (ESG) perspective.
Assessment of these dynamics helps to highlight companies experiencing positive operational momentum, and whether these businesses’ outlook is improving (whether this be the result of internal or external factors). This will be considered in the context of the wider market, the industry and the company’s own history, and further emphasises the importance of high-quality company management.
Georgina and Katen believe that the market often fails to adequately appreciate these ongoing dynamics, exacerbated by lower levels of broker research compared to the mega- and large-cap markets, and that this can lead to mispriced stocks offering the potential of a valuation re-rating. Valuation assessments are considered relative to the industry, the company’s history, and the wider market; the metrics used will vary by industry as appropriate.
Companies fitting the wider investment profile are generally those the managers consider to be well positioned to be structural winners going forward, such as their holding in OneSavings Bank. OneSavings Bank is a market leader in a niche market (buy to let) from which larger banking competitors would struggle to generate sufficient returns to make the costs of entry worthwhile to them. The wider market is, in Georgina and Katen’s view, applying too low a valuation to the business on perceived regulatory and political risk to the buy-to-let market. In their view, this is unlikely to materialise, and for the company to be trading on a valuation discount to the wider banking sector is unwarranted. This is particularly the case against a backdrop of strong UK mortgage data in December 2019, which should support the existing trend for strong growth in sales in a high-profit-margin business which has structural advantages to its peers due to established, existing operational infrastructure.
Sector allocations are unconstrained, but the managers have access to extensive in-house risk analytical systems. This allows Georgina and Katen to sense-check their portfolio positioning, ensuring they are not unintentionally becoming overly exposed to macroeconomic trends or stylistic factors. It is also used to ensure liquidity remains strong in the underlying positions.
Over roughly the past 18 months JMF has moved from an underweight to an overweight exposure to domestic UK revenue generation on a look-through basis. This was an outcome of the stock-picking process, which was highlighting greater relative opportunities in UK domestic revenue generators, but one of which Georgina and Katen were acutely aware. They first neutralised this exposure to roughly the market level (c. 52% of revenues generated in the UK) during Q4 2018, before gradually moving to a mild overweight throughout 2019.
This reflects the managers’ view that, despite recent outperformance, there remains a long-term catch-up opportunity for UK domestic companies relative to their more international peers (as we discuss in the Performance section). Mean reversion does not happen in a vacuum but Georgina and Katen observe that mixed UK economic data is now more than discounted in stock-market valuations, and that corporate buyers are recognising this (helping to drive a significant amount of merger & acquisition activity in the UK market). With greater political clarity following the 2020 general election, they believe international investors (who have been substantially underweight UK assets relative to history) will increasingly return to the UK market in continuation of the inflows seen in recent weeks.
JMF currently has net gearing of c. 9% (as of 20/02/2020). 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), and 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.
The board has specified that it expects gearing to stay within a range of between 5% net cash to 25% geared. Gearing is implemented through bank borrowing facilities totalling £45m (or c. 13% of NAV at current levels), with the option of increasing this further by £15m.
JMF’s returns under Georgina’s tenure have been strong (with Katen joining in April 2014), with share price and NAV returns of c. 290% and c. 232% respectively from 01/04/2012 (the first full month with Georgina as lead manager) to 14/02/2020. This represents significant outperformance of the wider peer group, which has produced share-price and NAV returns of c. 119% and 102% respectively. Similarly, a passive product tracking the benchmark FTSE 250 Index would have returned c. 129% over this period; the mid-cap focus has been a tailwind for JMF over this period, but the investment strategy has clearly contributed positively as well.
returns vs peers and index
The past 12 months to 14/02/2020 have seen a particularly strong period of performance for JMF, with share-price returns and NAV of c. 38% and c. 33% respectively. This compares favourably with the wider peer group, with average share-price and NAV returns of c. 19% and c. 17% respectively, whilst a FTSE 250 tracker returned c. 18%.
Stock-specific factors contributed to most of the outperformance seen in 2019, with holdings such as JD Sports, Games Workshop and Intermediate Capital Group notable contributors; that these were all top-ten positions entering 2019 is a further positive indicator that position sizing has proven beneficial and that the investment process (with the attendant stock conviction it builds) has contributed positively.
This represented a strong degree of outperformance but not an unprecedentedly strong period, as we can see in the graph further below. This shows the rolling 12-month returns relative to the benchmark index (as represented by a passive investment product) and the wider sector average NAV.
In the chart below, we can see that returns under Georgina’s tenure have been consistently positive. Over the period under review, rolling 12-month returns have been superior to the benchmark on c. 71% of occasions. Notable exceptions were in early 2016 and late 2018. In the former, the trust was negatively impacted following the result of the Brexit referendum; whilst Georgina and Katen had partially reduced their exposure to the domestic UK consumer ahead of the polling day (and essentially removed gearing from the portfolio) in recognition of the output from their risk analytics, the resultant sell-off in sterling and UK domestic assets nonetheless proved a headwind. The latter half of 2018 saw a headwind from three factors: widespread risk-off sentiment, not owning certain index constituents which benefitted from being the subject of takeover offers, and some stock-specific factors.
rolling 12-month returns relative to peers group and index
Relative NAV returns to both the peer group and benchmark have on average been positive in both rising and falling markets (as represented by the FTSE All-Share over a 12-month period), but particularly so in rising markets. Unsurprisingly, outperformance on the upside has been stronger during periods where the FTSE 250 Index is rising, though JMF NAV returns have (again, unsurprisingly) on average underperformed its peers and the benchmark during periods where the FTSE 250 Index has been declining.
Georgina and Katen are cognisant of the strong degree of outperformance seen in recent months from mid-caps, domestic UK assets and their own portfolio. However, as we have noted in the Portfolio section, they observe that they expect these assets to be the likely beneficiaries of sustained outperformance over the medium term due to wide valuation discounts in UK equities relative to global peers and the anticipated return of significant capital flows from international investors.
JMF shares currently yield c. 2.1% (as of 20/02/2020). 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.
However, whilst not the primary focus of the manager, the board does look to increase the dividend by at least the rate of inflation. Over the past five years to the end of the financial year 2019, the trust has comfortably achieved this 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. Nor is this a reading skewed by a recent special dividend; whilst JMF has paid out special dividends in four out of the past five financial years, it did not do so in 2019.
The dividend has increased every year since 2013/14, when it was flat; a special dividend was paid in 2013.
Following the paying of the final dividend for 2019, JMF will have c. £9.5m of revenue reserves, representing ample revenue reserve cover of c. 1.36x of the financial year 2019 dividend. This should support continued dividend growth in the event that earnings are not sufficient to do so; however, there has been no need for this in recent years, with earnings outstripping dividends. The board has, over this period, consistently distributed around 85% of earnings as dividends, opting to continue to strengthen the revenue reserve.
dividend 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. 2.7% (as of 14/02/2020), having seen a substantial narrowing in the discount in the latter half of 2019 as sentiment towards domestic UK assets improved. Georgina was named manager of JMF in March 2012; since 01/04/2012, the average discount has been c. 9.6%, whilst over the past 12 months it has averaged c. 8.4%.
This was particularly notable in December, as political risks abated. This was in line with a general improvement in sentiment towards the sector as a whole but, as can be seen in the graph below, was more keenly felt by JMF.
JMF’s discount has typically displayed greater volatility than the AIC UK All Companies peer group, likely as a result of perception that as a mid-cap fund it is more exposed to the domestic UK economy and thus that its portfolio would be more vulnerable to shifts in market sentiment relative to some peers. 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. Historically it has used this sparingly, and has not explicitly put a floor level at which it will buy back shares to seek to limit the discount. Nonetheless, over the calendar year 2019 the board repurchased a total of 53,321 shares at an average weighted discount of c. -10.9%.
JMF has an OCF of 0.87%, marginally 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. £382m, this represents a weighted management fee of c. 0.63%. There is no performance fee. The KID RIY figure is 1.27%, slightly above the sector average of 1.22%; 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 of 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 the 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 has recently been 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.