JPMorgan US Small Company I JSCSX

Effective May 31, 2023, Jonathan Tse will no longer be a listed manager on JPMorgan U.S. Small Company. Tse has been with J.P. Morgan since 2004 and served as a comanager on this strategy since November 2019. Tse was a member of the four-person quantitative research team conducting research in support of the group's investment process, including alpha and risk model development, portfolio optimization, and performance attribution. Head of quantitative research Wonseok Choi and fundamental managers Phil Hart, Akash Gupta, and Robert Ippolito remain in place. Given their continued involvement, Tse’s departure does not affect JPMorgan U.S. Small Company's People Pillar rating of Average and its Morningstar Medalist Rating of Neutral.

JPMorgan U.S. Small Company added another factor and another comanager in 2022, but its process still relies on several common factors, resulting in a Morningstar Analyst Rating of Neutral across all share classes.

This strategy combines quantitative and fundamental elements to try to outperform the Russell 2000 Index. It’s sensible and repeatable, but not very distinctive. It starts with a quantitative model that screens the Russell 2000 for stocks displaying the best combination of value, quality, and momentum characteristics. Previously the model only looked at value and quality factors, but within the past year the team began looking at momentum, focusing on trends in short interest among several others. The model also includes more advanced features, such as 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.

Five comanagers, including recently promoted Robert Ippolito, help run this strategy. Lead manager Phil Hart pilots the efforts on the fundamental side, while Wonseok Choi heads the quant group, but there have been several moving pieces around them. In September 2021, comanager Lindsey Houghton left for Harbor Capital after more than 15 years with J.P. Morgan. They also lost a pair of quant analysts in 2022 after losing one in 2020. The remaining team has the benefit of leaning upon some of J.P Morgan’s broader resources, but the increased turnover is a concern.

Under Hart’s leadership, performance has been decent. From Hart’s start in November 2010 through October 2022, the fund’s institutional shares returned 10.4%, slightly ahead of the Russell 2000 Index’s 9.8%. A recent stretch of strong performance helped these numbers, as the strategy beat the index by more than 4 percentage points over the trailing 12 months ending in October. The strategy’s target factors have been in favor recently, and their attractiveness will largely dictate the fund’s performance.

The managers’ model screens for value, quality, and momentum traits using both traditional and non-traditional methods. More routine criteria include price multiples to assess value and the level of cash flow relative to earnings to assess quality. Now, the model also tests for short interest trends (among others) to evaluate momentum. Proprietary techniques add some flair, but they aren’t revolutionary. For instance, the firm developed natural language processing algorithms to scrape insights from earnings call transcripts regarding the quality and attitude of management. The model 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. 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. In 2020, for example, value stocks underperformed meaningfully, which triggered a shift in the portfolio toward companies trading at lower valuations to take advantage of the perceived dislocation.

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

The strategy held 466 stocks as of September 2022, 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 Russell 2000 Index. Indeed, the fund’s largest active GICS sector position was a modest 3-percentage-point underweighting to consumer discretionary. The portfolio's active share (a measure of differentiation relative to a benchmark) regularly ranks among the lowest in the small-blend Morningstar Category.

According to Morningstar’s risk model, the strategy tilts as expected toward value, quality, and momentum factors. For value, the portfolio’s average price/earnings, price/book, and price/cash flow multiples were all lower than the index in September. The quality tilt is defined here by a focus on cash flows and return of capital to shareholders, which are less obvious in traditional metrics, but the portfolio did sport a higher average return on equity and return on invested capital than the index. For momentum, the team primarily looks at trends in short interest and earnings momentum.

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. Ippolito was recently promoted to comanager in November 2022 after serving as an analyst at J.P. Morgan for 13 years. 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. Choi is joined by comanager Jonathan Tse and several other quant analysts. The group also works together on several other small- and smid-cap strategies, including Neutral-rated JPMorgan Small Cap Sustainable Leaders VSSCX and JPMorgan Market Expansion Enhanced Equity ETF JMEE.

At the end of 2019, Hamilton Reiner took over as the head of J.P. Morgan’s structured equity department and 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 in Hart's group.

While the overall team has adequate resources, it has had to navigate a handful of departures in recent years. Most notably, former comanager Lindsey Houghton left the firm after 15 years in September 2021 for Harbor Capital. The quant group also lost two analysts in 2022 and another two years prior. Fortunately, Hart, Choi, and their colleagues have enough resources to pick up the slack.

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 that time through October 2022, the fund’s institutional shares returned 10.4%, slightly ahead of the Russell 2000 Index’s 9.8% gain. Compared with its small-blend Morningstar Category peers, performance looks even stronger, as it beat its average peer by 1.4 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. Furthermore, out of the 109 rolling three-year periods over Hart’s tenure, the strategy has outperformed the benchmark 55 times (almost exactly half) by an average of less than 0.1 percentage point.

While the fund has not historically been a noteworthy downside protector, it has performed well over 2022’s market drawdown. Over the trailing 12 months ending October 2022, the strategy has outpaced the benchmark by 4.6 percentage points. Morningstar’s risk model attribution shows that the strategy’s exposure to value and quality factors have driven the outperformance. The strategy’s newest tilt towards momentum did not have much of an impact. While most of these factors propelled the strategy over the past year, investors shouldn’t expect these factors to always be in favor.

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 Analyst Rating of Neutral.