Results analysis: JPMorgan Smaller Companies

• Today JPMorgan Smaller Companies (JMI) released its half year results for the period ending 31 January 2021. Over the six months to 31/01/2021 JMI produced share price total returns of c. 42.9% and NAV total returns of c. 30.9%, outperforming the benchmark Numis Smaller Companies plus AIM (excluding Investment Trusts) Index which rose by c. 28.7%. Over this period, JMI’s discount narrowed from 13.7% at the start of the financial year to 6.0% as at 31/01/2021. 
• The managers sought to maintain a balance between exposure to companies they observed as suffering minimal or no operational impact from COVID-19, and companies which, though heavily impacted by the COVID-19 pandemic, they believed were well positioned to emerge with a strengthened market position. As an end to lockdowns draws nearer, they have started to add further to a number of positions which they expect to benefit from the re-opening of the economy.
• The board recognises that there continues to be uncertainty in global markets. However, it believes this only further underlines the attractiveness of smaller companies, which are able to ‘make their own success’, regardless of macroeconomic headwinds.
• The managers are optimistic on the outlook for the UK. They anticipate significant pent-up demand will be released as lockdown policies are phased out, offering the potential for strong economic growth in the latter part of 2021. However, they note that challenges remain in the near-term and that they anticipate a rise in insolvencies in small- and mid-cap UK companies in the first part of 2021.

Kepler view

JPMorgan Smaller Companies (JMI) continues to represent a compelling proposition for investors. The trust has now delivered NAV total returns of 107.4% over the past five years to 25/03/2021, in comparison to 64.6% from the benchmark and 61.4% from the peer group average (Source: Morningstar).. At a portfolio level, the managers have been careful to strike a balance between COVID immediate ‘beneficiaries’, where operations were unimpacted or even boosted by lockdown policies, and companies for which any benefit may be more long-term in its nature. Companies from both categories have contributed to returns, with major contributors to performance including Jet2, OSB, Codemasters and Ergomed.

As a route to an end to lockdown policies became more tangible, the management team have been adding to a number of positions they anticipate benefitting from the re-opening of the economy, such as National Express and Marstons. Accordingly, JMI now has a strong overweight to the UK economy and domestic revenue generation when compared to the benchmark. If, as they anticipate, the very elevated household savings rate does indeed indicate pent-up demand which will be unleashed into the economy later in 2021, we would expect holdings such as these to further take up the reins and help drive performance.

The gearing facilities have been relatively fully utilised, reflecting the bullish outlook of the managers and the abundance of stock-specific opportunities they are observing at this time. Noting their view that the UK economy could see an accelerating recovery later in 2021 and that government and central bank policy is likely to remain supportive for the foreseeable future, they do not believe current UK market valuations are in any way demanding. These valuations, which they believe to be attractive, are before a full recovery in earnings is yet factored in. We would agree there is a compelling valuation opportunity in the UK market, and a more rapid vaccine rollout compared to peers should allow more rapid normalisation of economic activity in the UK. This in turn can create demand for UK assets in general, and should, we think, make the domestic revenue generation overweight in JMI more attractive.

Despite the bias towards UK domestic revenue generation, the balanced input to stockpicking, which helps ensure company specific developments are driving relative returns, should mean shareholders are able to rest assured that they are not beholden to a particular market or macroeconomic outcome to drive relative and absolute returns, in our opinion. Over the long-term, the experience and analytical resources available to the two managers in a lightly researched market should offer significant opportunities for alpha generation, and over the five years to 25/03/2021 JMI has displayed an annualised alpha of 4.3 and an annualised information ratio (relative to the benchmark) of 0.9 (Source: Morningstar).

Although the discount has narrowed significantly since the start of JMI’s financial year, this has been a reflection of wider market demand with no board intervention in the form of buybacks. The trust still remains on a discount of c. 3.6% (as at 25/03/2021), but further shareholder uplift from discount narrowing may be limited and this is notably narrower than the typical discount level seen in recent years. Nonetheless, the ability to buy into what appears a cheap asset class, via a vehicle whose managers have generated long-term outperformance, at a discount to NAV remains compelling to us.

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