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JPMorgan Small Cap Sustainable Ldrs R5 VSSCX

Analyst rating as of
NAV / 1-Day Return
36.96  /  1.68 %
Total Assets
94.4 Mil
Adj. Expense Ratio
0.700%
Expense Ratio
0.700%
Fee Level
Low
Longest Manager Tenure
12.07 years
Category
Small Blend
Investment Style
Small Blend
Min. Initial Investment
0
Status
Open
TTM Yield
0.00%
Turnover
140%
unlocked

Morningstar’s Fund Analysis VSSCX

Analyst rating as of .

A tough time to pivot to sustainability.

Our analysts assign Neutral ratings to strategies they’re not confident will outperform a relevant index, or most peers, over a market cycle.

A tough time to pivot to sustainability.

Associate Analyst

Summary

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JPMorgan Small Cap Sustainable Leaders’ recent mandate shift and continued team turnover lead to a Morningstar Analyst Rating of Neutral across all share classes.

Formerly JPMorgan Small Cap Core, this strategy transitioned to a sustainability focus in July 2021. Previously, a model sifted through the Russell 2000 Index looking for stocks with the best combination of value and momentum characteristics. Now, lead manager Phil Hart and his team curate a list of companies that they consider leaders in their respective industries on ESG stewardship. From there, the surviving names are put into essentially the same quantitative model as before, though it now includes a third factor: quality.

The resulting portfolio looks vastly different from its previous iteration. It is now much more concentrated and tends to be underweight in energy and materials stocks. Adding the quality factor has also given the portfolio a slight growth tilt compared to its previous value/blend profile. These changes have tended to result in more volatile performance, especially compared to its previous form.

Hart still leads the team, with comanager Wonseok Choi heading up the quant efforts, but there have been several changes 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.

The strategy’s new sustainability focus has only been in place for a mere 16 months, but so far, performance has been quite poor. From July 2021 through October 2022, the fund’s Institutional share class’s 24.7% cumulative decline was well behind the Russell 2000 Index’s 18.8% drop. The timing of the mandate change was unfortunate; the strategy’s underweighting to energy and slight growth tilt have been major headwinds in 2022.

Process

| Average |

A recent switch to a focus on sustainability doesn’t much change the fact that this strategy focuses on common factors, resulting in an Average Process rating.

Unlike its previous iteration, manager Phil Hart and his team play a greater role in this strategy’s process, though the quant model designed to drive outperformance remains largely the same. The investment universe here was previously the Russell 2000 Index, but now it is only firms within that index deemed to be “best in class” from an ESG perspective. Hart and three analysts curate a working list of such companies, which are then fed into a quant model that constructs a portfolio of stocks scoring the best on more traditional factors such as value, momentum, and quality, subject to tracking error constraints relative to the benchmark. The quality component was added to the model in 2021 during the mandate shift and primarily looks for earnings backed by strong cash flows and effective capital deployment.

Comanager Wonseok Choi works with Hart and J.P. Morgan’s equity data science team to explore new automated techniques to extract value from data. Recent initiatives include using natural language processing to scan through earnings-call transcripts for clues regarding a company’s business momentum and an algorithm designed to replicate J.P. Morgan analyst-assigned quality scores. The overlay of ESG criteria might make the strategy’s performance more differentiated but it won’t necessarily lead to superior performance on its own.

People

| Average |

A recent string of team turnover weakens an otherwise well-resourced group, warranting an Average People rating.

Phil Hart has led this strategy since November 2010 (when it was a broad small-cap equity strategy), 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 on three other small-cap strategies, including Neutral-rated JPMorgan US Small Company JUSSX 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 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. The team will also utilize J.P. Morgan’s fundamental U.S. equity research team for assistance on specific ESG issues.

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. On the quant side, the group also lost two analysts in 2022 and another one two years prior. Fortunately, Hart, Choi, and their colleagues have enough resources to pick up the slack.

Parent

| Above Average |

J.P. Morgan Asset Management’s strong investment culture, which shows through its long-tenured, well-aligned portfolio managers and deep analytical resources, supports a renewed Above Average Parent rating.

Across asset classes and regions, the firm's diverse lineup features many Morningstar Medalists, such as its highly regarded U.S. equity income strategy that’s available globally. There's been some turnover in the multi-asset team recently, but it remains deeply resourced and experienced. Manager retention and tenure rates, and degree of alignment for U.S. mutual funds compare favorably among the competition. Managers' compensation emphasizes fund ownership over stock ownership, which is distinctive for a public company.

The firm continues to streamline its lineup and integrate its resources further. For instance, in late 2019, the multi-asset solutions division combined with the passive capabilities. The firm hasn’t launched trendy offerings as it’s mostly expanded its passive business lately, but acquisition-related redundancies and more hazardous launches in the past weigh on its success ratio, which measures the percentage of funds that have both survived and outperformed peers. Fees are regularly reviewed downward globally; they're relatively cheaper in the U.S. than abroad. Also, the firm is building its ESG capabilities and supports distinctive initiatives on diversity.

Price

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It’s critical to evaluate expenses, as they come directly out of returns. 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.

Performance

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The strategy’s recent change in mandate makes its relevant track record quite short. Nonetheless, performance so far has struggled under its new sustainability focus. Since shifting its mandate on July 1, 2021, the fund’s institutional share class lost a cumulative 24.7% through October 2022, well behind the Russell 2000 prospectus benchmark’s 18.8% drop and way behind its typical small-blend Morningstar Category peer’s 12.3% decline.

The timing of the mandate switch was unfortunate. The strategy’s severe underweighting in energy proved to be quite a headwind, as energy was the Russell 2000’s best-performing GICS sector in the first 10 months of 2022. The losses continued into other sectors with some poor picks in materials and consumer discretionary. Healthcare was one of the strategy's few bright spots in 2022, with solid picks in HealthEquity HQY and Sarepta Therapeutics SRPT.

Previously, the strategy stayed fairly close to the benchmark in both composition and performance. From lead manager Phil Hart’s November 2010 start until the mandate change, the fund’s 13.6% annualized gain edged out the benchmark by 0.2 percentage points. Under the previous mandate, the managers kept sector exposures much closer to the index and had a much lower tracking-error target. The new portfolio’s greater concentration and tilt toward ESG-friendly stocks could increase volatility.

Portfolio

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A mandate shift has completely transformed this portfolio. It used to hold between 400 and 500 stocks and track the sector composition of the Russell 2000 Index rather closely, but with ESG playing a role since July 2021, it is now much more concentrated and differentiated. As of September 2022, it held just 88 stocks, with notably fewer holdings in the energy sector. The percentage of assets invested in the top 10 holdings increased from about 8% at the start of 2021 to more than 25% by September 2022. But that’s not to say that the team is making massive bets in individual positions; no holding was more than 3% of assets in September. Top holdings included Sarepta Therapeutics SRPT, a biotech company focused on treating rare infectious diseases, and Huron Consulting Group HURN, a global consulting firm headquartered in Chicago.

As a result of its pivot, the strategy’s style profile also became more growth oriented, though it remains in the blend section of the Morningstar Style Box. Historically, it hovered around the blend and value portions, but the addition of a quality factor and shift away from resource-related stocks was enough to alter the skew. While the managers scrapped a 1.5-percentage-point limit on the portfolio’s deviation from benchmark sector weightings, the portfolio remains diversified, with exposure to all economic sectors. The only stocks the portfolio can’t own are those involved in the production of alcohol, firearms, tobacco, gambling products, and thermal coal.