JPMorgan US Small Company A JTUAX

JPMorgan US Small Company’s largely quantitative approach is sensible, but tight constraints and several recent team changes limit this strategy’s appeal.

Industry veteran Phil Hart has led this strategy since 2010, but it is more of a group effort. Hart, along with comanagers Akash Gupta and Robert Ippolito, handles the fundamental efforts on this strategy, while Wonseok Choi heads the quant group. The four managers have all worked on J.P. Morgan’s US Structured Equity team for more than 15 years, but there have been several moving pieces around them. In September 2021, fundamental comanager Lindsey Houghton left J.P. Morgan after more than 15 years, while quant comanager Jonathan Tse left the strategy in May 2023, though he remains with the firm. The remaining team has the benefit of leaning on some of J.P Morgan’s broader resources, but the increased turnover is a concern.

The 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 in the lowest decile of its actively managed small-blend Morningstar Category peers.

Since Hart took command of this strategy in November 2010 through July 2024, the institutional shares’ 11.1% annualized return was slightly ahead of the Russell 2000 Index’s 10.4%. A recent stretch of strong performance has boosted this record, however, as the strategy’s 5.0% annualized return over the trailing three years through July was 3.1 percentage points ahead of the index. In 2021 and 2022, the strategy’s value and quality tilts boosted performance, while more recently its momentum exposure has propelled performance.

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 and the level of cash flow relative to earnings to assess quality. 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 dataset 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 strategy’s three targeted 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 mostly resemble its Russell 2000 benchmark, though its strategic factor weightings toward value, quality, and momentum are apparent.

The strategy held 490 stocks as of June 2024, on the higher side of its historical norm of about 400. 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 1.8-percentage-point underweighting to technology. Furthermore, the portfolio's 63% active share (a measure of portfolio differentiation relative to a benchmark) in June ranked in the lowest decile of all active small-blend Morningstar Category peers.

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 fundamental metrics. For example, the portfolio's value tilt can be seen with its average price/earnings and price/cash flow multiples all being lower than the index's in June 2024. The quality tilt can be seen with higher profitability ratios like return on equity and return on invested capital. For momentum, Morningstar's risk model showed a stronger momentum exposure 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 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 managers are all veterans on J.P. Morgan’s US Structured Equity group, working together on several other small- and smid-cap strategies, including JPMorgan Market Expansion and JPMorgan Small Cap Value.

Two additional fundamental analysts with over a dozen years of industry experience and four more quant analysts round out the team. While the group has adequate resources, it has had to navigate a handful of departures in recent years, raising some uncertainty. Most notably, former fundamental comanager Lindsey Houghton left the firm after 15 years in September 2021, and quant comanager Jonathan Tse left the team in May 2023, though he remains with the firm. In addition, several analysts on both the quant and fundamental teams have departed in recent years. Fortunately, Hart, Choi, and their colleagues have enough resources to pick up the slack.

J.P. Morgan is a well-resourced, diligent, and responsible steward of client assets. Investment teams are seasoned and stalwart, especially in equity and fixed income, the latter of which has successfully undergone substantial transformation in recent years. The firm offers competitive compensation that is aligned with fundholders and shows strong retention at senior levels of the organization. It demonstrates a culture of constant innovation and willingness to evolve. For example, J.P. Morgan recently expanded its investment committee process through which senior leaders review various teams and strategies, and it continues to develop proprietary portfolio management and risk oversight tools. Some funds still face high fee hurdles, but the firm has generally lowered expenses as it has grown.

The firm isn't without its complications. J.P. Morgan's product offering is extensive, and some areas need improvement. For instance, its multi-asset business has faced some challenges as a result of complex investment processes. The firm continues to build out its footprint in China, but its efforts there remain unproven. Although not every strategy is the best in its class, J.P. Morgan remains earnest in the pursuit of excellence, and investors are well-served.

From then through July 2024, the institutional shares’ 11.1% annualized return was ahead of the Russell 2000 Index's 10.4%. Compared with its small-blend Morningstar Category peers, performance looks even stronger, as it beat its average peer by 1.3 percentage points.

The strategy's tightly constrained process has led to performance that hasn’t deviated too much from the benchmark. Indeed, the fund posted a tracking error (a measure of how closely a strategy follows its benchmark) of just 2.8% during Hart's time, which ranked in the lowest decile of all actively managed category peers.

Despite these constraints, the strategy has performed quite well in recent years. In 2021 and 2022, 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. In 2023, the strategy lagged its index, largely because of stock-specific factors, as the portfolio’s healthcare and tech names underperformed. Through the first seven months of 2024, the strategy has bounced back nicely, though, thanks to a strong boost from its momentum exposure, which was added to the model in early 2022.

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.