Results analysis: JPMorgan UK Smaller Companies

• JPMorgan UK Smaller Companies (JMI), formerly JPMorgan Smaller Companies, has reported strong results for the year ending 31 July 2021. Outstanding returns from UK smaller companies have been accompanied by substantial outperformance. JMI’s NAV total return was 68.1% compared to a 50.3% total return for the Numis Smaller Companies plus AIM Index (excluding Investment Companies). The share price total return was 79.4% as the discount narrowed from 13.8% to 8.0%. As of 11/10/2021 the discount was 9.6% (Source: JPM Cazenove).
• The board have confirmed a final dividend for the financial year of 5.7p per share, an increase of 3.6% from the 2020 dividend of 5.5p per share. Due to the level of dividends received from portfolio companies not having fully recovered in the aftermath of the Coronavirus outbreak, the trust’s payout for the year was supported by revenue reserves. 
• Over the period the trust benefitted from positions in defensive names robust to the effects of the pandemic (for example, Ergomed, a pharmaceutical service provider) as well as discounted cyclical names that suffered from the initial impact of the pandemic and were bought on weakness, but emerged stronger in the recovery as weaker competitors fell by the wayside, an example being Jet2. 
• During the year, the trust bought into four IPOs, all technology related, selectively participating in this nascent but growing sector of the UK market. The portfolio has also benefitted from the heightened M&A activity in the UK market, with three companies held being bid for.
• The managers have a bullish outlook on both the UK economy and UK smaller companies, reporting that median earnings are forecast to grow 18% this year and 19% next year as the recovery continues. With the Numis index at a forward P/E ratio of 14.1x the managers believe that the market is fundamentally undervaluing this growth potential.
• Due to the significant rise in the trust’s assets the board has increased the revolving credit facility to enable the managers to gear up to the limit of 10% of net assets set by the board, if they so choose. As at 11/10/2021, the facility totalled £50m with an option to increase to £60m and the gearing of the trust stood at 9.4%. 
• In terms of corporate governance, the board are signalling their commitment to following best practice. The board has employed Lintstock to evaluate their performance, Lintstock being a board advisory firm that provides objective and independent counsel to over 120 companies in the UK and internationally. Additionally, all the directors will stand for reappointment at the forthcoming AGM.
• Commenting on the performance of the trust over the last year, the chairman stated: ‘The [managers] are to be congratulated as they have kept cool heads and negotiated the evolving pandemic with skill and an eye to opportunity. Their many years of experience and robust investment process have enabled them to capitalise on the strong recovery as lock-down restrictions have eased, fuelled by continued government and central bank stimulus.’

Kepler View

The recently renamed JPMorgan UK Smaller Companies (JMI) has posted a year of excellent results. This has contributed to an outstanding long-term track record of outperforming their benchmark and peers; the trust is ranked 3/14 within its peer group over the last five years for NAV total returns (as at 11/10/2021, source: JPMorgan Cazenove).

This success has been based on the experience of the long-standing managers Georgina Brittain and Katen Patel (tenures beginning in 1998 and 2014 respectively) following a well-established process combining a quantitative system balancing quality, valuation and momentum factors with bottom-up fundamental analysis, all supported by the deep resources of JPMorgan Asset Management. We note that balancing the portfolio between ‘growth’ (higher quality, premium) stocks and more cyclical, less expensive ‘value’ stocks has helped the portfolio to navigate the extreme style rotations that have occurred in the last year, most notably the shift from growth companies outperforming in the immediate recovery phase following the March 2020 crash whipsawing into a rally in value stocks following the announcements of successful vaccine trials in November 2020.

After such a year of strong gains, albeit from a depressed baseline, investors will naturally ask if there are further gains to be made or if markets will consolidate. We think this will heavily depend on the strength of the ongoing economic recovery, especially domestically, as the managers have chosen to be overweight UK revenue generation based on their favourable in-house economic view. The overall UK equity market appears to be still suffering from the Brexit hangover, trading cheaply relative to global peers, with the broader UK market being valued at 12x forward P/E versus the US at 21x (as at 06/10/2021, source: Yardeni Research). This could be justified by the low growth prospects of the large, ‘old economy’ stocks making up the FTSE 100; however the prospects for smaller companies are very different. The wave of innovative tech related IPOs suggest a major shift in the make up of the UK market is underway, opening new opportunities and prospects for UK small cap investors. Even in cheaper, older companies private equity firms seem to see value given the well-publicised levels of M&A activity. We think there are a number of reasons to be bullish on UK smaller companies: low starting valuations, supportive monetary and fiscal policy and pent up demand from consumers to name just a few.

For an investor with a bullish outlook on the asset class and UK economy, we think JMI is a way of gaining exposure that balances the potential for outperformance without making a binary stylistic bet. If the ongoing rally in UK smaller companies is led by cheaper ‘value’ stocks driven by broad economic recovery or if the newer tech ‘growth’ sectors begin to emerge as winners then JMI should benefit either way. Additionally, as JMI scales up in AUM the tiered management fee scale (0.75% on gross assets up to £200m, 0.65% on gross assets over £200m) and economies of scale on fixed costs should provide a small kicker as the trust becomes more cost effective.

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