JPMorgan Smaller Companies (JMI) aims to give investors access to fast-growing, innovative smaller companies that often have their own structural growth drivers, making them less directly linked to the performance of the overall UK economy.
Georgina Brittain has managed this trust for more than 20 years and was joined by Katen Patel six years ago. The team uses a bottom-up stock picking approach to take advantage of the inefficiencies in the small-cap market that offer a diverse range of alpha-generating opportunities. The team uses both quantitative and fundamental analysis to find companies that exhibit quality, momentum and value characteristics, creating a diverse portfolio of 88 holdings. The largest sector overweights come from the media (6.3%), leisure goods (6.2%) and financial services (3.9%) sectors. At the other end of the spectrum, the trust has little exposure to support services (-3.1%), travel and leisure (-2.9%) and pharma and biotech (-2.7%) relative to the benchmark.
Returns over the long term have been impressive for the trust, which has outperformed the benchmark in eight of the past ten calendar years. Over a five-year period, the trust has generated NAV total returns of 55.1%, once more beating the benchmark’s return of 29.6%, as well as the AIC and IA peer groups, which returned 51% and 53.3% respectively. More recently, the trust’s performance has been a tale of two halves. The trust was hit particularly hard during the fourth quarter of 2018, losing close to 20% NAV total returns. Since then the trust has bounced back, returning NAV total returns of 19.3%, double the benchmark returns of 9.9% and considerably more than the AIC peer group (12.8%) and the IA peer group (12.1%).
Alongside capital appreciation, the trust offers investors a reasonable level of income. Currently the trust yields 2.4% and the dividend has increased by 23.7% over the past five years. Nevertheless, the trust has had a stubborn discount since the European Union membership referendum in 2016 and over the past year the trust has traded, on average, at a discount of a little under 15%. Currently the discount sits at 14%, as at 26 Jul 19.
JMI offers investors the chance to invest in some of the most innovative and exciting companies that the UK has to offer. The case for smaller companies as a long-term investment is extremely compelling, and the manager’s clear, repeatable process makes the trust an attractive way to take advantage of this, in our view.
The trust’s current discount of 14% is one of the widest in the sector and there are multiple trusts with considerably worse performance figures trading at narrower discounts. We believe this could therefore provide an extra impetus behind the share price when sentiment improves towards UK small caps, which could benefit investors who take a long-term view and invest on this attractive discount.
|Wide discount even relative to worse performing peers||High levels of gearing can see the trust amplify volatility, as we saw in Q4 of 2018|
|Strong track record over the long term relative to the benchmark and peers||Stubborn discount due to continued uncertainty surrounding the UK|
|Highly experienced fund manager with two decades' experience on the trust||Dividends are variable to the trust is unlikely to appeal to income-seekers|
JPMorgan Smaller Companies aims to give investors access to fast-growing, innovative smaller companies that often have their own structural growth drivers, making them less directly linked to the performance of the overall UK economy. The trust is managed by Georgina Brittain and Katen Patel, who use a high-conviction, bottom-up stock picking approach and look to take advantage of a market that continues to be inefficient and offers a diverse range of alpha-generating opportunities. The long-term performance of the trust shows their process can take advantage of these inefficiencies, as the trust has outperformed the market significantly.
Objective and repeatable quantitative research coupled with fundamental analysis is at the heart of the trust’s process. In particular, the team looks to find companies that exhibit quality, momentum and value characteristics. To identify quality businesses, the managers look at their profitability, the sustainability of their earnings and the capital allocation of the business, aiming to identify structural long-term winners. In comparison, when looking at the valuation aspect of a company, the team look at P/E and the free cash flow. For momentum, the managers look at price movements, particularly whether they reflect recent earnings statements, and the outlook for the company.
Alongside a disciplined approach to buying, the managers place great importance on the discipline of selling. This involves monitoring the holdings for fundamental changes in business prospects, as well as persistent assessment of the earnings momentum and ESG factors. The managers also aren’t afraid to run their winners and have no formal guidelines in place for how long they can hold a company; however, they will sell if the company enters the FTSE 100. An example of this is JD Sports, which the team bought at a market cap of approximately £200m and sold with a market cap of over £5bn when it entered the FTSE 100 earlier in 2019.
Typically the portfolio will have 60 to 90 holdings and, with 88 holdings at the time of writing, the trust is towards the upper end of the limit. As can be seen below, the largest sector overweights come from the media (6.3%), leisure goods (6.2%) and financial services (3.9%) sectors. At the other end of the spectrum, the trust has little exposure to support services (-3.1%), travel and leisure (-2.9%) and pharma and biotech (-2.7%) relative to the benchmark.
The sector positioning has seen some changes over the past year, primarily due to the trust changing benchmark. The new benchmark, the NUMIS Smaller Companies plus AIM ex IT, has more constituents and is significantly more balanced than the FTSE Smaller Companies Index. The most meaningful change has been in the financials sector, which was previously an underweight position due to the larger number of REITS in the trust’s old sector. The change of benchmark also saw the company add some larger market cap companies, including the likes of Dunelm and DFS.
Looking forward, the team recognises it is difficult to predict the short-term performance of the UK market. While we still await clarity on the outcome of Brexit, economic growth is uncertain and this has been weighing heavily on investors’ minds. With this said, they point out that unemployment continues to fall and wage growth has been picking up nicely. Alongside this, they say valuations across the UK market continue to be attractive and corporate activity high. The managers therefore continue to be positive, and believe that by identifying fundamentally sound UK smaller companies, they will continue to be well positioned to deliver attractive returns.
Gearing is a regular feature of the trust and the company’s gearing policy is to operate within a range of 10% cash and 10% geared. The trust has a £25m borrowing facility expiring in October 2019. The trust also has access to overdrafts, to allow the managers to act flexibly.
As can be seen in the graph below, gearing is a relatively constant feature of the trust and the one-year average for the trust sits at 10.3%. Although this has been one of the causes for outperformance relative to peers over the past five years, the trust found itself hit particularly hard in the correction in the fourth quarter of 2018, when it was 13% geared. The trust reacted by dropping gearing in Q1 of 2019 to as low as 5%, although this has since crept up to close to double digits (9.2% as of 8 July 2019).
Returns over the long term have been impressive for the trust. Over a ten-year period (to 12 July 2019) the trust has NAV total returns of 348.7%, considerably outperforming the benchmark (Numis SC Plus AIM Ex IT), AIC UK Smaller Cos and the IA UK Smaller Cos sectors, which delivered 203.9%, 319.8% and 286.3% respectively. In fact, and as can be seen below, the trust has outperformed the benchmark in eight of the past ten calendar years.
Over a five-year period, the trust has generated NAV total returns of 55.1%, once more beating the benchmark, at 29.6%, and the AIC and IA peer groups, which returned 51% and 53.3% respectively. Over that period, it has generated 3.73% annualised alpha - middle of the pack for the sector. The trust’s volatility, meanwhile, is around average for the peer group, at 13.19%.
Five year chart
Looking more recently, the trust’s performance has been a tale of two halves. The trust was hit particularly hard during the fourth quarter of 2018, and lost close to 20% NAV total returns, relative to 14.6% from the benchmark. This was partly due to the large level of gearing the trust had, as we discuss in the gearing section, but also due to the performance of some stocks leading up to the correction. The companies that were hit hardest during the correction were mainly those that had performed well leading up to it.
Since then, performance has once more been strong. The trust has delivered NAV total returns of 19.3%, double the benchmark returns of 9.9% and considerably more than the AIC peer group, at 12.8%, and the IA peer group, at 12.1%. Much of this has been due to the stock picker’s environment we now find ourselves in, and the team have managed to avoid the pitfalls and benefit from some extremely strong performances from the likes of Games Workshop, Future and 4imprint, all of which have had a positive impact of well over 1% in the year to the end of May 2019.
one year graph
With the aim of trying to give investors access to the fast-growing, innovative smaller companies that help drive the UK domestic economy, it would be a reasonable assumption that the trust would not pay a dividend. However, the trust currently yields 2.4%, offering investors a decent level of income alongside potentially strong capital returns. The board’s policy is to distribute substantially all of the income received, and it notes that distributions are likely to vary with the income received by the trust.
Dividends are paid annually and, for the 2018 financial year, the trust delivered a dividend of 27p per share, up 17.4% from the 23p in 2017. The revenue return per share for FY18 also increased to 30.7p, growing from 24.2p in 2017. This improvement was due to a blend of companies increasing their dividends, a higher level of special dividends and changes in the composition of the portfolio.
It should be noted that since the figures for FY18 were published, the trust has undergone a share split, which saw the division of each ordinary share into five. As such, the graph below shows the dividends in the relation to the new weighted average number of shares.
At the helm of the portfolio are Georgina Brittain and Kaeten Patel. Georgina has been working in the industry, and JPMorgan, for close to 25 years and has run this trust since 1998. She currently holds the title of managing director and is the fund manager of multiple UK small and mid-cap funds alongside JMI, including the open-ended JPMorgan UK Smaller Companies Fund and the JPMorgan Mid Cap Investment Trust. She is also a co-manager for a range of European small cap funds.
Katen has been working in the industry for 14 years, six of those at JPMorgan. He was named co-manager in 2014. He is also Georgina’s co-manager on the JPM UK Smaller Companies Fund and the JPMorgan Mid Cap Investment Trust. Previously he worked at HSBC in a European equity sales role.
JPMorgan Smaller Companies has had what could be described as a stubborn discount since the referendum in 2016. Over the past year, the trust has traded, on average, at a discount of a little under 15% and it currently sits at 14.4%. As we discuss in the performance tab, this is far from a reflection of the returns the trust has generated, but instead a reflection of the outlook for the UK, in particular smaller companies. On top of this, the UK Smaller Companies sector is extremely competitive, with 15 constituents. However, we see little reason for the trust to continue trading at the current level and should some of the macro and political uncertainty surrounding the UK subside, we believe that this will be one of the first UK trusts to benefit.
The company aims to keep the discount under 15% and has been purchasing shares back when it reaches this level. According to the latest interim report, over the six months to 31 January 2019, the trust repurchased 16,319 shares for cancellation over the six-month period. This was done at an average discount of 15.1%, with the key objective of reducing the volatility of the discount.
The trust has an ongoing charges figure (OCF) of 1.03%. This compares to a sector-wide average of 1.05% and leaves the trust in the top half of the 15-strong sector for cheapest OCF. Of this, the trust charges 0.80% of gross assets up to £200m and 0.70% on gross assets over £200m for the management fee. The trust has no performance fee.
The KID RIY for the trust is 1.38, compared to a sector average of 1.66. With this said, it should be noted that the calculation methodologies can vary among companies.