Jupiter US Smaller Companies (JUS) will be renamed Brown Advisory US Smaller Companies (BASC) in mid-May, subject to shareholder approval, after the mandate was taken over by the new manager on 1 April 2021. Chris Berrier heads up the Brown Advisory US Small Cap Growth team, and is the new lead manager. He has run the same strategy in the open-ended space since 2006, which has outperformed both the small cap Russell 2000 index and the Russell 2000 Growth. As discussed in performance, the Brown Advisory US Small-Cap Growth strategy’s performance over the past five years has been particularly strong, and it has continued its longer-term trend of generating above-market returns with below-market levels of risk.
Chris’ strategy is essentially a quality growth approach. He aims to find companies that can demonstrate consistent growth ahead of the market over the long run, typically via opening up a new market, dominating a niche, or having a differentiated business model or product. This is encapsulated by the proprietary concept of ‘3G’ – growth, governance and go-to-market, as discussed in performance.
The growth strategy is a departure from the value strategy implemented by the former manager, who announced his retirement last October. While most trusts in those sectors have since seen their discounts narrow, JUS’ discount remains wider than the sector averages at 5.9%. The only US small-cap peer is trading on a small premium.
As a part of the new management contract, the board has negotiated a fee cut, with the management fee falling by 5bps, and a tiered system introduced which will see it fall further as and when net assets grow. The trust does not pay a divided.
We think US small caps are at a potentially exciting entry point, with the progress of the vaccination programme, and state re-openings, giving the domestic US economy a boost. The coming stimulus package of the Biden administration should boost economic activity further, which should be disproportionately felt in the more domestic-facing small caps. Over the past few years, large caps have outperformed small caps, a reversal of the long-run tendency in the US. Regulatory pressures on the large-cap tech stocks, as well as high valuations in some areas of the market, give reasons to doubt this trend will continue.
The arrival of the Brown Advisory US small-cap growth strategy into the closed-ended sector could therefore prove to be well-timed. Chris and the team bring with them an enviable pedigree, with long-term outperformance of their style index as well as the small-cap index, most impressively achieved with relatively low risk.
In our view, this has opened up a potentially interesting discount opportunity in the shares. The one US small-cap peer, JPMorgan US Smaller Companies (JUSC) is trading on a 3.5% premium while JUS is trading on a 5.9% discount. Yet the Brown Advisory US Small Cap Growth strategy has outperformed JUSC in recent years, and offers similar stylistic exposures. We think some unfamiliarity with the new manager, some delayed impact of the poor performance of the old manager, and the news of the manager change not spreading has led to this disparity.
|New manager has an excellent track record of outperforming a tough market to beat
||Value has been outperforming growth since Q4 2020, and may continue to do so
|The current economic environment seems bullish for US small caps
||At c. £168m in net assets, the trust will be too small for some professional investors
|The discount seems anomalous compared to the closest peer
||There may be an overhang of investors who invested for the previous manager or a value strategy
Jupiter US Smaller Companies (JUS) is shortly to be renamed Brown Advisory US Smaller Companies, subject to shareholder approval, in recognition of the arrival of the trust’s new manager following Robert Siddles’ retirement. The new manager is Chris Berrier, who, since taking control on 1 April 2021 is reshaping the portfolio in line with the US Small Cap Growth strategy he has run for Brown Advisory for almost 15 years. While both old and new manager aim to be long-term shareholders and look through market noise, the new strategy is a quality growth approach in sharp distinction to the value strategy employed in the past. The small-cap growth strategy has proven highly successful since Chris took over in 2006, particularly on a risk-adjusted basis, as we discuss in performance. JUS will be the only way to access this in the closed-ended strategy, which brings with it various advantages including the ability to take on gearing.
While Chris is the lead manager, and he is supported by associate manager George Sakellaris, the strategy employed is heavily team-based, leaning on the detailed fundamental research of a team of 11 sector specialists sitting within a US equity team of close to 50 professionals. Chris believes that having the right people is critical to success, and his approach ensures the whole team has input into stock selection and sales via discussing all ideas together before he makes the final decisions (see management).
The basic aim is to find companies which can generate compound growth higher than the market over the long run. There is therefore a strong quality growth tilt to the strategy which contributes to the attractive downside performance characteristics. While debt/equity is high in absolute terms, as the below table shows (of a representative small-cap growth account as of 31/12/2020), it is low compared to a highly geared growth index. This is in part due to the strategy avoiding early stage, unprofitable companies. The focus on repeatable earnings and downside risk means there is a bias to companies with a track record and good cash generation. Similarly, the portfolio is typically light on biotechnology, which in the small-cap space often means companies with a high potential to fail.
|Representative US Small Cap Growth account
||Russell 2000 Growth
|Number of holdings
|Average market cap ($bn)
|Consensus earnings growth estimates 3-5yr (%)
|Active share (%)*
|Three-year trailing portfolio turnover (%)
Source: Brown Advisory, as at 31/12/2020
The high active share of over 90% speaks for itself. Chris does consider the Russell 2000 and Russell 2000 Growth indices when thinking about the construction of his portfolio, but does not manage to the indices at all. In our view, this is a highly attractive characteristic for a US manager, where the high degree of efficiency in the market – and possibly the high number of benchmark-hugging mutual funds – means that it has historically been rare to generate alpha. While the earnings growth estimate is slightly below that of the growth index, Chris tells us he finds this an unreliable guide to future performance. Furthermore, the fact he rarely invests in unprofitable companies tends to bias down the long-term earnings growth, as Chris finds analysts typically ascribe these very high expected growth rates.
Unsurprisingly for a growth strategy, the valuation is high. In fact, it is significantly higher than that of the growth index. As of 31 March 2021, the Brown Advisory US Small-Cap Growth strategy’s forward P/E ratio, on 2022’s expected earnings, was 30.1x compared to 23.4x for the Russell 2000 Growth. Chris views valuations in the context of their level relative to growth. This means he is willing to pay more if he believes the long-term growth prospects justify it, although there has to be a clear path to those earnings and he will cut a position if the outlook changes. Typically, therefore, this valuation sensitivity means the portfolio is underweight high momentum growth stocks which are swept up according to sentiment.
Chris believes that idea generation is critical to the success of a small-cap strategy – with an investable universe of over 2000 companies to choose from, getting to the preferred 80 companies efficiently is going to be challenging. Many managers handle this through the use of quantitative screens. While the Brown Advisory team do use screens, they are only one tool within the process, and typically used at a very initial phase to exclude companies with poor liquidity or growth characteristics. Chris believes they can focus minds too much on the past, whereas future growth prospects are more important regarding future returns.
The team conduct around 500 meetings a year, looking for companies that display their ‘3G’ characteristics. This is the key input into the qualitative screen from which ideas come, with analysts proposing their ideas that come out of these visits via a note for all to discuss. Chris is keen to get differing viewpoints on all these ideas and will seek out negative views on proposed stocks too in order to test the thesis. Once he is satisfied, the idea is either progressed or discarded.
The ‘3Gs’ - durable growth, sound governance, and scalable go-to-market strategies - are therefore critical to understand what the portfolio is aiming to achieve and how it is likely to behave. The first element is Growth. Here the team look to identify companies with durable growth prospects. This is likely to mean companies that are market leaders in their niches or are likely to rapidly gain market share. It also means companies with a differentiated business model, and a large or growing market to operate in.
The second element is Governance. As a part of the qualitative analysis, the analysts look for strong management teams with a history of shareholder-friendly behaviour. They look for well-aligned incentives which encourage management to act in shareholders’ interests as well as diverse and appropriately structured boards.
The third element is ‘Go-to-market’. By this is meant the economic profit earned by the company, which comes through in high return on invested capital and, ideally, margins that grow as the business expands with limited capital required relative to the revenue on the table. This quality is often found in technology companies, particularly software, and the Brown Advisory strategy has tended to be overweight in this sector. However, the portfolios have reduced IT exposure in recent months thanks in part to valuations leading the team to draw back a little after a strong run, particularly from hardware. The avoidance of early-stage, unprofitable companies also contributes. The sector weighting below is from an illustrative account as of 31/03/2021. We note the strategy tends to be biased away from commodities. Similarly, financials and utilities are generally underweights as Chris believes they are often driven by exogenous factors which are hard to predict. The below chart is relative to the small-cap growth index, showing the portfolio is underweight these areas even relative to the growth benchmark let alone the broad index. Chris took over the trust on 1 April 2021 and we understand the portfolio will be quickly brought in line with the broader strategy, with minimal differences from the open-ended funds run in accordance with it.
Chris and the team take the attitude that they are owners of equity rather than renters of stock, meaning that they aim to be long-term shareholders and contribute to the growth of the company. Three to five years is a typical investment horizon, although ideally positions would be held for much longer. The turnover ratio over the past three years has been 38%, consistent with an average holding period of just under three years. This is similar to the average of 35% over the past three years from the other AIC North American Smaller Companies, JPMorgan US Smaller Companies.
Ideally, Chris wants to find companies when they are at a relatively early stage of development and hold onto them as they grow. Not only is this a clear strategy to generate alpha but it also reduces trading costs, and Chris believes it is also good for the risk-adjusted performance of the portfolio. This is because, as companies grow, if they have been well-chosen, their operational risk will decline and along with this volatility. This and the quality bias help on the downside, and as we highlight in performance below returns have been particularly strong on a risk-adjusted basis.
Similarly, a focus on prudent diversification helps reduce risk. Over the last three years, the portfolio has consistently held between 70 and 80 stocks. There is just 28% in the top ten positions, with no position been approaching 5% (see table below), so problems in single stocks can have only a limited impact on the portfolio. While all companies are invested in on their own merits, a lot of work is done to track and control underlying risk exposures which can affect buy and sell decisions or weightings. This includes quantitative tools tracking sensitivity to macro factors, sharp valuation moves in underlying companies and more qualitative risk inputs such as ESG factors. This work helps towards creating what Chris calls an “all-weather portfolio”, with strong downside protection as well as growth potential.
TOP TEN HOLDINGS
Holding in Representative Account
% of portfolio
|Charles River Laboratories
|Bright Horizon Family Solutions
|Hain Celestial Group
Source: Brown Advisory, as at 31/03/2021
JUS had a loan facility that was terminated in September 2020, prior to the change of manager. It currently has no gearing, therefore, and in fact a net cash position. This was 7.3% at the end of March 2021, before the new manager took control. The cash in the Brown Advisory US Smaller Companies Growth strategy was 3.3% at the end of that month. We understand there are no immediate plans to initiate leverage. However, over the long run the manager may use gearing selectively for specific opportunities, but there will not be a persistent or high use of leverage.
Since Chris took over the lead role on Brown Advisory’s Small Cap Growth strategy, it has managed to outperform both the Russell 2000 index of small-cap stocks and the more demanding benchmark of the Russell 2000 Growth. The Brown Advisory US Smaller Companies UCITS fund was launched in November 2007 and has generated 11.1% per annum, according to Morningstar data. The Russell 2000 Growth has generated 10.7% over that period and the Russell 2000 9.8%. The superior returns have been achieved with a beta of just 0.9 to the Growth Index and a downside capture ratio of 0.84, so are particularly superior on a risk-adjusted basis. (We would add that fees have fallen over this decade and a half, and so the returns to unitholders would have been higher had the current fee arrangements been in place.)
Performance has been particularly strong over the past five years. The open-ended fund has returned 148.2% in total return terms compared to 136.7% for the growth index and 113% for the broad small-cap index. Again, this has been achieved with superior risk performance, in terms of beta, downside capture and volatility. The below chart shows the cumulative relative performance of the fund versus both indices. The outperformance of growth versus the broad market can be seen taking off in early 2019, while the alpha generation versus both indices was also strongest during the following period.
FIVE-YEAR PERFORMANCE OF OPEN-ENDED FUND
Past performance is not a reliable indicator of future results
Value has outperformed growth since the vaccine rally kicked in last autumn. Chris did reduce some expensive technology names and shifting slightly to consumer durables as the reflationary trade kicked in, with relative valuation playing a part. However, this is a resolutely growth strategy and no wholesale changes were made. As such, the strategy will be most successful when the growth style is in favour and if the trend to value continues it could underperform. We note year-on-year growth and inflation numbers are likely to be very high over the next few months thanks to their base month in 2020 seeing huge falls in activity due to the lockdowns. This could mean that in the short-term value continues to outperform, although we believe that whether a medium-term inflationary environment pertains after that is much more dubious.
Over the past five years, JUS has underperformed the small-cap market and its only peer in the AIC US North American Smaller Companies sector, JPMorgan US Smaller Companies. This reflects the returns to the more value-tilted approach taken by the former manager, Robert Siddles. JUS returned 99.5% to 15/04/2021, while the rival trust made 120.2%. We note this means the Brown Advisory open-ended fund has handsomely outperformed JPMorgan US Smaller Companies as well as JUS. This has been a strong period for large caps, particularly large-cap tech, and we note the AIC North America sector weighted average total return is 146%. Despite the disadvantage of investing in small caps during this period, the Brown fund has nearly kept pace. It is historically unusual for large caps to outperform small caps, and after this period small caps are trading on cheaper valuations than large caps, which we think makes this an interesting entry point.
FIVE-YEAR PERFORMANCE OF PREVIOUS MANAGER
Past performance is not a reliable indicator of future results
The trust has a capital return objective and has not paid a dividend since 1998. Expenses are charged to the revenue account which offsets any income earned in a traditionally low-yielding market. There has been no change to the policy on the dividend since the new manager was appointed. We note the current yield on the Brown Advisory US Smaller Companies UCITs fund is 0.5%, low enough to be offset by the expected charges.
JUS is managed by Chris Berrier, portfolio manager of the US Small Cap strategy implemented in the open-ended space as well as in JUS. He is supported by associate portfolio manager George Sakellaris. Chris has managed the US small-cap growth strategy since April 2006, while George was appointed in 2014. Although Brown Advisory has run US small-cap growth strategies since the early 1990s, before it emerged from Alex Brown as a separate entity, Chris was instrumental in launching the current approach taken. In particular, he sharpened the focus on downside protection and examining the risk/reward skew which has led to attractive risk-adjusted performance metrics (see performance section). Chris and George work alongside 11 dedicated sector analysts and PMs within a broader equity research team of c. 50 individuals, focused predominantly on the US market.
Brown Advisory encourages a culture of employee ownership which influences the approach to portfolio management via a focus on shared responsibility. All employees own shares in the company, and there is a bottom-up approach taken across the business, with no CIO or house view. Before buy and sell decisions and during periodic reviews of holdings, reports are circulated around the team and views sought as part of the formal process. At times Chris will even seek out analysts to make the bear case for a company if he thinks the views on the team are too consistent.
JUS looks like a potential discount opportunity on the current 5.9%, which is substantially wider than the one US small cap-peer and the AIC North America sector average. The previous manager’s value-tilted philosophy had underperformed prior to the emergence of the pandemic, and with value-tilted strategies being out of favour during the lockdowns, the trust remained on a wider discount than its peer. With Robert Siddles having had a distinguished long-term track record, we think there may have been some shareholders personally loyal to him who have sold since he announced his retirement in October last year, which has also contributed to the discount.
We think there is potentially scope for this discount to close as investors become acquainted with the new manager. The pedigree of the new manager is a key reason. The US market is notoriously difficult to outperform, and Chris and his team have done so on the open-ended funds using this strategy. JUS is the only way to access this strongly performing strategy in the closed-ended structure. Furthermore, we think US small caps are particularly attractive at this point in time. The pace of vaccination and reopening is leading to strong economic performance in the US. After a period in which large-cap growth stocks have outperformed, the environment seems more conducive to the more domestic-focused small caps.
The board has committed to using buybacks to prevent the discount from remaining over 10% over a period of time, in normal market conditions. It stuck to this even after announcing the proposed new manager, with buybacks continuing until the discount narrowed below 10% during March 2021.
One of the advantages of shareholders of the change of management is the lower management fee negotiated by the board. The new management fee will be 0.7% of the first £200m of net assets, 0.6% on the next £300m and 0.5% on any net assets above £500m. With net assets currently at £168m, the fee will therefore be 0.7%. This is lower than the 0.75% earned by the previous manager, while the tiered fee will ensure that long-term shareholders will pay a lower fee as net assets rise. The ongoing charges figure (OCF) was 0.97% when last calculated, although this reflects the previous management arrangements. Looking forward, the management fee will reduce the OCF. There are some costs associated with the change of manager which could increase it (albeit for one period only), although Brown Advisory has agreed to cover some of these. The latest KID RIY is 1.2%, although as with the OCF this reflects the previous arrangements. With the new management fee, BASC looks likely to remain highly competitive on a fee basis versus its peer JPMorgan US Smaller Companies, which has an OCF of 1.23.
Brown Advisory has devoted considerable resources to ESG research, with a team of five dedicated analysts sitting within the equity team. In keeping with the approach of the equity analysts, they perform detailed proprietary analysis rather than relying on external sources. They seek to identify areas in which Brown Advisory can have an impact as a large institutional investor, as well as monitoring the risks and exposures of the team’s funds.
The Brown Advisory Small-Cap Growth strategy is a fundamental strategy rather than a dedicated ESG or sustainable strategy. This means that it is at the portfolio manager’s discretion to incorporate such matters as he or she sees fit, and there is no standardised ESG reporting. The main input of ESG into this strategy is via risk management and monitoring. Here the analysts can use the proprietary ESG risk assessments to understand the relevant risks in their positions.
Clearly this is not a dedicated ESG strategy, and so investors demanding that will likely be disappointed. However, there is a commitment by the broader business to company engagement and contributing to the resolution of societal issues such as climate change which means these matters are not ignored.