JPMorgan US Smaller Companies tests the small but mighty maxim

We recently wrote about the Association of Investment Companies’ North America sector in the run-up to the US Presidential Election next week, covering the Baillie Gifford US Growth Trust [LON:USA]. However, the AIC has another North American sector, the North American Smaller Companies Sector.

It is a much smaller sector than the AIC’s main North American sector, with only two funds which are Brown Advisory US Smaller Companies [LON:BASC] and the JPMorgan US Smaller Companies [LON:JUSC]. However, smaller companies in the US are still considerable enterprises, companies up to USD2bn (GBP1.5bn).

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Historically US smaller companies have performed better than large cap companies over the longer term, offering a small cap premia. However, this small cap premia has diminished over the past five years, not only in the US, but in the UK. There’s a number of reasons why smallcaps have underperformed, mainly there has been a flight to quality from investors as economic conditions have become more difficult. Moreover, smaller companies when compared to larger companies, have a harder time getting hold of money for growth capital, they are charged higher interest rates and get shorter term loans from banks, and there is less liquidity in their equity markets and so have found growing more difficult.

Change in nature of larger US companies

Largecaps, were traditionally older industrial legacy companies, however, today the world’s biggest companies are now concentrated on future-industries – specifically technology, and investors (many who are dazzled by shiny new things) have gravitated towards these companies. And yes, largecaps have outperformed smaller companies in the US, but research from Blackrock showed that over the last five-years, if you took technology out of the large cap sector (S&P500) the performance of large cap index isn’t quite as attractive when compared to the smaller end of the market.

Liquidity has also been an issue for smallcaps, with private companies deciding to stay private longer, with many private companies taking longer to go public and then sometimes jumping straight into the big leagues. The election – and its closeness – has caused instability and uncertainty for investors. But in a week’s time – one would hope – the world will know who the 48th president of the US is and the potential direction of travel for the world’s largest economy. Investors like stability and a new president in the Oval Office will give a measure of stability, and one would surmise that the US Equity markets (despite being one of the best-performing markets this year) will experience a period of growth and recovery. History has shown that in a recovery period smaller companies outperform larger caps, so now might be the time to invest in this sector.

Best performing fund in sector

Of the two, in performance terms, the GBP305m JPMorgan US Smaller Companies is the superior fund. Over the last year (on a share price total return to 30th October) the JPMorgan fund returned +31.6%, 7.9 percentage points ahead of Brown Advisory. Over three years, JPMorgan returned +38.6%, 11 percentage points ahead of Brown Advisory and over ten-years JPMorgan returned + 185.7% against Brown Advisory’s +114.5%.

Benchmarked against the S&P500 Index  and founded in January 1982, JPMorgan’s fund is managed by Don San Jose who has been with the bank since 2000. San Jose is assisted by Dan Percella and Jonathan Brachle. The fund aims to provide investors with capital growth by investing in US smaller companies that have a sustainable financial competitive advantage.

As the emphasis is on capital growth rather than income, shareholders should expect the dividend to vary from year-to-year. The fund focuses on owning equity stakes in businesses that the managers believe trade at a discount to intrinsic value, with strong management teams. The fund has the ability to use borrowing to gear the portfolio within a range of 5% net cash to 15% of net assets.

JPMorgan US Smaller Companies top five holdings 

Large caps have benefitted from macroeconomic conditions, and government and central bank policy, but this could be on the verge of reversing with smaller companies benefitting disproportionally compared to larger ones. Also, regulatory changes to index composition might soon see smaller companies automatically fall into the universe of tracker funds which will address liquidity issues, and we could be about to see a resurgence in fortunes for smaller companies.

While the recent underperformance of US smaller companies has been a concern, the potential for a reversal in fortunes is significant. As economic conditions stabilise and the US presidential election concludes, smaller companies may benefit from increased investor interest and favourable market dynamics. With experienced management teams and a focus on long-term value, funds like JPMorgan US Smaller Companies are well-positioned to capitalise on this opportunity.