JPMorgan US Equity R2 JUEZX

Greater confidence in the investment process of the JPMorgan US Select Equity strategy (which includes the U.S. mutual fund, U.K., and Luxembourg vehicles) leads to a Morningstar Analyst Rating upgrade to Silver from Bronze or to Bronze from Neutral, depending on share class fees. The most expensive share classes remain Neutral.

J.P. Morgan handed manager Scott Davis the keys to this strategy in 2019 for European vehicles and in February 2020 for the U.S. mutual fund, and it has been a good decision thus far. Rather than maintain the previous multimanager structure, the firm consolidated the assets to be steered solely by Davis, who had been the top-performing sleeve manager. But performance wasn’t the whole story, as Davis’ investment style warranted a broader platform to shine. Cultivated over his roughly eight years as a manager, his process is rooted in a close collaboration with sector-focused equity analysts, a more concentrated portfolio than before, and keen attention to overall portfolio risk exposures relative to the S&P 500 benchmark. The results have not only been strong but also consistent with his stated goals of generating alpha through stock selection and keeping tracking error (volatility relative to the S&P 500) within a reasonable range.

Davis’ investment process is a blend of art and science, and its underlying pillars of conviction and creative portfolio positioning can be relied upon. A challenge for a large-blend fund is that it needs to be different enough from the benchmark to outperform net of fees, but without getting burned when an index constituent (particularly a larger one) that the fund doesn’t own outperforms. Davis accounts for this by holding a concentrated selection of analysts’ top ideas while solving for a way to balance the portfolio’s factor exposures and market risks. For instance, as of September 2022, the portfolio maintained an underweighting to the benchmark’s largest holding, Apple AAPL, yet Davis controlled for this by investing in Teradyne TER, a supplier to Apple, which had a more favorable analyst ranking. Such moves apply at the sector level, too: In an effort to mitigate the portfolio’s exposure to interest-rate movements, Davis offset an overweighting to bank stocks heading in 2022 with a larger stake in utilities stocks.

Davis relies heavily on J.P. Morgan’s core research team of 20-plus analysts with over a decade of experience on average, a more formidable resource than many competing shops can trot out. Analysts now have a portion of their compensation tied to this offering, which further helps align incentives.

Few active offerings have been able to outpace passive benchmarks in the large-blend Morningstar Category. This strategy offers a better shot than most to buck the trend.

Manager Scott Davis has shown that he has the creativity and attention to detail necessary to pilot this somewhat concentrated offering. Despite generally investing in 50-60 stocks, this portfolio hasn’t behaved all that differently from its S&P 500 benchmark, and that is due to Davis’ work alongside J.P. Morgan’s central team of sector analysts. Analysts rank stocks in their coverage universe based on fundamental analysis viewed through the lens of a proprietary discounted cash flow model. Each one will have top-rated stocks (those with the best risk/reward outlook), but Davis doesn’t invest in all of them. He challenges analysts on their picks to find those that withstand greater scrutiny, and importantly, ones that help build a portfolio that will substantially assume the same factor risks as the benchmark. The portfolio’s sector weightings tend to differ with those of the benchmark as Davis considers the correlations between stocks more so than their official labels.

The result is a differentiated portfolio but one that behaves like a more diversified one. Davis utilizes a quantitative model to backtest hypothetical portfolios, but much of his work is focused on forward-looking risks that cannot be captured by historical data.

Davis is fairly agnostic from a style perspective, though he admits he has a slight preference for stocks with healthier financials in market-leading positions. Still, the portfolio has tended to fall in the blend section of the Morningstar Style Box, reflecting a broad approach.

This portfolio finds a balance between differentiation and careful risk management. The U.S. mutual fund held 52 stocks in September 2022, significantly less than the 140-180 it had previously under three independently managed sleeves. However, manager Scott Davis’ desire to let stock selection drive results leads to only moderate sector bets relative to its S&P 500 benchmark. Davis also considers factor exposure when building the portfolio. For instance, he increased the portfolio’s stake in financials companies toward the end of 2020 to bolster its exposure to cheaper, more cyclical stocks to help offset its lack of exposure to the energy sector.

The strategy also holds a couple of stocks not in its benchmark, such as global semiconductor firms NXP Semiconductors NXPI and ASML Holdings ASML. Davis feels justified in owning these companies as a significant portion of their revenues is derived from the United States. The vast majority of the strategy’s assets are invested in U.S.-domiciled firms.

The portfolio has historically leaned a bit more toward a growth style than its benchmark, but it has only been a slight bias.

This strategy continues to rely heavily on J.P. Morgan’s core research team, but it is now led exclusively by Scott Davis, who oversaw the strongest-performing sleeve of this formerly multimanaged offering. Davis became a named manager in August 2014, inheriting a 10% slice of the strategy, but quickly saw his share grow, most notably after manager Thomas Luddy stepped down at the end of 2017. Before being awarded full control here, Davis managed 65% of the fund alongside comanager Susan Bao’s 10% and an analyst-directed sleeve representing 25%.

Davis continues to leverage the ideas of J.P. Morgan’s core research team, which consists of 20-plus analysts with extensive industry experience. That group tends to see an analyst or two leave each year—sometimes to a different team within the firm—but capable replacements are consistently found. Analysts now have a portion of their compensation tied to this fund’s performance, which helps align incentives.

Davis now has additional support from Shilpee Raina, a former analyst on Gold-rated JPMorgan Equity Income HLIEX, who became a named comanager in November 2021. Raina has a generalist background but most recently specialized in consumer stocks, an area in which the team could use additional support after parting ways with a pair of underperforming analysts in 2021.

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.

Since manager Scott Davis’ August 2014 debut through November 2022, the U.S. mutual fund's institutional share class gained an annualized 11.6%, which beat the S&P 500’s 11.3%, and the large-blend Morningstar Category average of 9.1%. While that time frame includes contributions from other manager sleeves, Davis’ stand-alone track record from a similar separately managed account performed better than the overall fund.

The strategy’s edge versus its benchmark is slim, but it has handily outpaced most peers. As of November, it landed in the top decile of large-cap blend category rivals over the trailing three-, five-, and 10-year periods. It has been a touch more volatile, though, but not enough to spoil its advantage. Its Sharpe ratio, a measure of risk-adjusted return, has tended to exceed that of its average rival.

Stock selection, as opposed to sector or industry allocation, has been the key driver of the fund’s excess returns. Top picks over Davis’ tenure include industrial REIT Prologis PLD, UnitedHealth UNH, and Tesla TSLA.

Performance through the first 11 months of 2022’s downturn has been middling, though the picture improves after considering the recent market cycle’s upswing in 2020 and 2021.

Based on our assessment of the fund’s People, Process, and Parent pillars in the context of these expenses, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Bronze.