Kepler Trust Intelligence
Updated 16 Feb 2022
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by JPMorgan UK Small Cap Growth & Income. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Life isn’t always easy as a fund manager, particularly during a market bubble. Asset prices soar upwards and while you may be making the right move in the long term by not jumping on the bandwagon, failing to do so can make your portfolio’s performance look lacklustre in comparison to those who have.

The team at JPMorgan UK Smaller Companies (JMI) have had to endure this experience during the past couple of years. Even though the trust has consistently outperformed its benchmark over the last decade, both as a whole and on a yearly basis, it did not buy into some of the more ebullient members of the UK small cap market during the pandemic.

Most notable among these were Ceres Power and ITM Power, two companies in the renewable energy sector. Both firms had produced triple-digit year-on-year share price returns in the middle of 2021, complete with multi-billion pound market caps.

A disciplined approach

The result was such that anyone who didn’t hold the two firms had a couple of significant detractors on their performance relative to the benchmark for a period of time. But the good thing about bubbles, at least for those that don’t invest in them, is they usually end up getting popped by reality.

Since reaching some seriously heady heights in early 2021, both Ceres and ITM have lost over half of their value, with neither one currently showing promising signs of a recovery.

Avoiding companies with no earnings, trading at 100x revenue isn’t proof that you’re a genius but it at least suggests you’re unlikely to dive into whatever the next ‘hot’ stock is and end up wrecking a portfolio.

For the JMI team, it’s also an example – albeit rather an extreme one – of the benefits their more disciplined approach to the market can yield.

Strong track record

Managed by Georgina Brittain and Katen Patel, the JMI portfolio tends to hold between 60 to 100 small or mid-cap UK stocks. The goal is to put together a portfolio of high conviction stocks, which have better value and quality characteristics relative to the wider market.

As noted, JMI has historically outperformed its benchmark, the Numis Smaller Companies plus AIM (excluding investment companies) Index. This is not a matter of a few basis points either. In the decade up to the end of January 2022, JMI’s total share price returns were more than 2.5x the equivalent figure produced by the index.

For Brittain and Patel, those results reflect the opportunities the market they invest in offers. Smaller companies tend to receive less research coverage, meaning there is more room to buy stocks at attractive valuations.

The JMI portfolio contains a broad mix of companies, some of which would probably sit in the value category and others in the growth bucket. In the never-ending debate about the merits of these two investing styles, JMI’s approach, one which has paid off in the past, is more about buying companies it thinks are good and not paying too much for the pleasure of doing so.

A mixed portfolio

Alpha FX is one example of this. The London-based firm provides a mix of currency and payment solutions, and its shares would be more likely to sit in the growth bucket of a portfolio. Revenues at the company have increased more than five-fold since 2016, and the firm’s latest half-year results showed a near doubling in year-on-year revenue.

With operating margins averaging around 30% over the past five years, the company is also highly cash generative – something the JMI team are keen on in their investments. Its share price has performed extremely well as a result, despite being relatively ‘expensive’ by some valuation metrics.

Lending group OSB shares some similar traits to Alpha FX. Like the foreign exchange company, it has managed to produce sizeable increases in revenue and earnings over the past five years. It also operates with attractive margins and has built up a very strong capital position which can be used to fund growth and pay dividends to shareholders.

The difference lies in its valuation. Whereas Alpha FX is an earlier stage business that appears to be priced for growth, OSB is more mature – its roots trace back to the 19th century - and trades at much lower valuation metrics, despite sharing many of the traits that the foreign exchange firm does.

Style - less important than delivering the goods

Both companies can fit within the JMI portfolio because the trust managers focus on buying shares at the right price, rather than obsessing about whether a firm should be classified as a value stock or not.

Determining the right price is down to a variety of factors, although Brittain and Patel do place a heavy emphasis on free-cash-flow yield. On that basis, the trust’s portfolio is substantially ‘cheaper’ than much of the market.

As we head into 2022 that could help support the trust’s performance. UK small caps continue to trade at low valuations, relative to both larger cap stocks in the same market and those abroad. This despite the fact they have a higher median earnings growth rate than any other segment of the UK equities market.

For those seeking exposure to UK small caps JMI could be an interesting option – particularly if they want managers that are likely to avoid those frothier areas of the market.

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