JPMorgan US Small Company I JSCSX

JPMorgan U.S. Small Company continues to come with some open questions that limit its appeal.

Veteran manager Phil Hart has led this strategy since 2010, but the pieces around him have been in flux. Hart pilots the fundamental efforts on this strategy alongside comanagers Akash Gupta and recently promoted Robert Ippolito, while Wonseok Choi heads the quant group. These managers are all experienced, but their team has lost a few key pieces in recent years. In September 2021, fundamental comanager Lindsey Houghton departed after more than 15 years with J.P. Morgan. More recently in May 2023, quant comanager Jonathan Tse left the strategy, though he remains with the firm. The remaining team has the benefit of leaning upon some of J.P. Morgan's broader resources, but the increased turnover is a concern.

This strategy combines quantitative and fundamental elements to try to outperform the Russell 2000 Index; it is sensible and repeatable, but not very distinctive. It starts with a quantitative model that screens the Russell 2000 Index for stocks displaying the best combination of value, quality, and momentum characteristics. While it will look at some traditional metrics such as P/E for value, it also includes many advanced features such as natural language processing that analyzes earnings call transcripts for possible indications about quality and momentum. Ultimately, the model builds a diffuse portfolio of 350 to 500 stocks, which limits the strategy’s ability to stand out. Indeed, the fund's active share, a measure of portfolio differentiation from a benchmark, regularly ranks among the lowest in the small-blend Morningstar Category.

Under Hart's leadership, performance has been competitive. From Hart's start in November 2010 through October 2023, the fund's institutional shares returned 9.0%, slightly ahead of the Russell 2000 Index’s 8.3%. A recent stretch of strong performance helped these numbers, as the strategy posted its best 24-month period ended in December 2022. During that time, the strategy outpaced the index by a cumulative 10.5 percentage points, fueled by its quality and value tilts that were in favor.

The managers' model screens for value, quality, and momentum traits using both traditional and nontraditional methods. Some of the more routine criteria include price multiples to assess value, the level of cash flow relative to earnings to assess quality, and trends in short interest for momentum. But these traditional metrics have become a smaller part of the model over the years, as the team continues to add new features. For instance, the firm developed a natural language processing algorithm to scrape insights from earnings call transcripts to assess momentum. Another component uses that same data set for clues on quality looking at management’s tone and language. The model then constructs the portfolio with stock, sector, factor, and thematic risk controls such that the resulting allocation isn’t too different from the Russell 2000 benchmark.

This strategy also draws upon fundamental insights. Manager Phil Hart and his team review proposed trades and conduct further analysis to improve the model’s accuracy, mostly to reflect one-time items or other material events rather than forecast earnings. The managers can also adjust the portfolio's exposure to any of the three factors based on rules flagged by the model. Typically, these top-down adjustments are made during periods of market stress when there is greater dispersion between factor returns.

The portfolio tends to resemble its Russell 2000 benchmark, though its strategic factor weightings toward value, quality, and momentum are apparent.

The strategy held 462 stocks as of September 2023, on the higher side of its historical norm of about 370. The quant model that builds the portfolio typically increases the number of holdings when volatility is higher. It diversifies its holdings across stocks and business types, seeking to remain roughly sector neutral relative to the index. Indeed, the fund's largest active GICS sector position was a 1.9-percentage-point underweighting to energy. Furthermore, the portfolio's 65% active share (a measure of portfolio differentiation relative to a benchmark) in September ranked among the lowest in the small-blend Morningstar Category.

While the model uses many nontraditional methods to assess value, quality, and momentum, the portfolio's tilt toward these factors still shows through in many traditional metrics. For example, the portfolio's value tilt can be seen with its average price/earnings, price/sales, and price/cash flow multiples all being lower than the index's in September 2023. The quality tilt can be seen with higher profitability ratios like return on equity and return on assets. For momentum, Morningstar's factor profile showed a stronger momentum score than the index.

Phil Hart has led this strategy since November 2010, but it is more of a group effort. Comanagers Akash Gupta and Robert Ippolito assist Hart on the fundamental side, covering stocks and vetting the quantitative model's proposed trades. The trio also works closely with comanager Wonseok Choi, who leads the team's quant efforts and oversees the development and analysis of the model that underpins the strategy's process. The group also works together on several other small- and smid-cap strategies, including JPMorgan Small Cap Sustainable Leaders VSSCX.

At the end of 2019, Hamilton Reiner took over as the head of J.P. Morgan's structured equity department. He encouraged increased interactions between Hart's team and the firm's broader resources. An analyst from the firm's equity data science division, who helped develop some of the factors used here, is now embedded with Hart and his team.

While the overall team has adequate resources, it has had to navigate a handful of departures in recent years, raising some uncertainty. Former comanager Lindsey Houghton left the firm after 15 years in September 2021. The quant group also lost two analysts in 2022 as well as comanager Jonathan Tse in May 2023, though he remains with the firm.

As of 2022, this investment stalwart manages more than USD 2.5 trillion in AUM. Composed of various global cohorts and diverse asset classes, the firm has more tightly integrated its capabilities in recent years, notably through the development of proprietary analytical and risk systems. Investment teams are robustly staffed and helmed by seasoned contributors. The firm’s strategies tend to produce reliable portfolios, and several flagship offerings are Morningstar Medalists. Manager incentives align with fundholders'; compensation reflects longer-term performance factors, and portfolio managers invest in the firm’s strategies as part of their compensation plans.

The firm’s funds tend to be well-priced, but they aren’t as competitive as many highly regarded peers of similar scale. Recent product launches include thematic and single-country strategies, both of which carry the potential for volatile performance and flows, along with misuse by investors. The firm remains intrepid when it comes to developing an environmental, social, and governance-focused framework and continues to move into other areas such as direct indexing through its 55iP acquisition and China through its joint venture, but these complicated initiatives take time to assess any real and lasting effect.

From November 2010 through October 2023, the institutional shares' 9.0% annualized return was ahead of the Russell 2000 Index's 8.3%. Compared with its small-blend category peers, performance looks even stronger, as it beat its average peer by 1.1 percentage points.

The strategy's tightly constrained process has led to performance that is closely in line with the benchmark. Indeed, the fund posted a tracking error (a measure of how closely a strategy follows its benchmark) of just 2.6% during Hart's time, which ranked among the lowest decile of all actively managed category peers.

Despite these constraints, the strategy performed very well in 2021 and 2022. During these two calendar years, the strategy's 1.8% cumulative return easily outpaced the benchmark's 8.7% loss. While some stock-specific factors did contribute to the outperformance, Morningstar's risk model attribution shows that the strategy's factor exposure to value and quality were the key drivers to its success. The momentum factor (which was added in early 2022) did not have much of an impact during this stretch. While momentum exposure benefited the offering in the first 10 months of 2023, its 4.7% loss during that stretch still lagged the index by 0.3 percentage points.

Based on our assessment of the fund’s People, Process, and Parent Pillars in the context of these expenses, we don’t think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Medalist Rating of Neutral.