JPMorgan SMID Cap Equity I WOOPX

JPMorgan SMID Cap Equity’s stable, proven team and differentiated investment process earn it a Morningstar Analyst Rating of Silver for its cheapest share classes and Bronze for pricier ones.

This strategy earns its keep by losing less in down markets, but an untimely underweight to energy stocks prevented it from delivering better results through the first five months of 2022 as the sector’s market value soared. Managers Don San Jose and Dan Percella sold the fund’s energy holdings in November 2020 when they inherited control from another management team. (They had previously done so at sibling fund JPMorgan Small Cap Equity VSEIX.) They felt it had become too difficult to find energy companies predictable enough to fit with their process, particularly given high commodity-price volatility. Unfortunately for the strategy, energy has outperformed all other sectors since that time, helping explain the fund’s pedestrian performance during the 2022 bear market: The institutional shares fell 14.4% for the year to date through May, trailing the Russell Mid Cap category benchmark by about 1.5 percentage points and the Russell 2500 prospectus benchmark by roughly 1 percentage point. However, outside of energy, portfolio holdings performed well and provided some ballast.

San Jose and Percella have managed this strategy since April 2016 in separate accounts that on their watch have outperformed both relevant benchmarks . The process is a carbon copy of their highly successful small-cap strategy but ventures further into mid-cap territory. While the comanagers have leaned on just two analysts, their focus on high-quality companies operating in niche industries keeps their sights narrow. Still, some extra help could be useful, and encouragingly, the team officially named Jesse Huang as an associate analyst in 2022. Huang has worked at J.P. Morgan for six years and assisted the team for the past four. His new coverage responsibilities will also help free up time for San Jose to carry out his duties as J.P. Morgan’s new CIO of value investing, a people management and oversight role. His primary job will still be managing his existing charges.

The strategy remains in capable hands and is a strong option for investors.

This strategy’s unique focus on quality companies in niche spaces earns it an Above Average Process rating.

The process here is all about finding great businesses priced as merely good ones. Managers Don San Jose and Daniel Percella scour the small-cap universe for best-in-class companies with consistently high levels of profitability that are led by management teams proven to be efficient capital allocators. They focus on companies operating in narrow niches, looking for those able to leverage their competitive positioning to protect and grow their returns on capital at rates higher than the market foresees. These traits, along with a preference for earnings and free-cash-flow over top-line revenue growth, lead them to steadier business models.

The team assess firms’ growth potential on a three- to five-year basis, but their view on margins tends to be the key differentiator. The team will happily own a company growing at a modest rate if it can expand its margins over time to produce strong earnings and cash flow that the market will reward. New positions are built out gradually as the managers look for validation of their investment thesis in the firm’s execution.

The managers trim holdings as they appreciate—few climb above 2.0% of assets—but tolerate higher valuations as long as their theses remain intact. They’ll hold onto their winners but will sell them once they become full-fledged large-caps.

While the fund’s name implies a blend of small- and mid-cap stocks, this is primarily a mid-cap portfolio. As of April 2022, about 64% of equity holdings were classified as mid-cap, with small-caps taking up about 30%. The portfolio’s largest positions tend to be anchored in steadier mid-cap stocks. Waste management company Waste Connections WCN, pool products distributor Pool Corp POOL, and BJ’s Wholesale BJ were among the top 10 holdings as of April.

Regardless of company size, the managers’ focus on quality is consistent. It scores higher than the Russell Mid Cap Index on metrics such as return on assets. Trailing earnings- and revenue-growth rates across the portfolio are a tad lower than the benchmark, which is consistent with the managers’ prioritization of profitability over growth.

The strategy typically invests across all sectors except energy, which the managers avoid because of its poor free-cash-flow visibility and high commodity-price volatility and. They may eventually invest in the sector, if signs emerge that energy companies’ management teams can be more judicious in their capital spending and production goals.

Recently initiated positions include a handful of healthcare-tech and software stocks. Both segments have been out of favor in 2022 and the managers have added to the holdings as their valuations declined.

A skilled and stable team earns the strategy an Above Average People rating.

Managers Don San Jose and Dan Percella have run this SMID-cap strategy in a separate account format since 2016. They know each other well having worked together on JPMorgan Small Cap Equity for over a decade. Analysts Jonathan Brachle and Chris Carter—each with more than 15 years of industry experience—support the managers. Jesse Huang was recently named as an associate analyst. He’s spent about four years with the team in a junior role and has earned the trust to cover stocks across a few sectors. That should help free up San Jose to attend to his duties as the new CIO of J.P. Morgan’s value equity unit, a people management and oversight role. Most of San Jose’s time will be spent managing portfolios, though.

The team sometimes collaborates with other JPMorgan Asset Management analysts but largely works independently. They’ve proved their worth over the years with strong stock picks, producing stellar risk-adjusted returns at this strategy.

While team members function as generalists, they tend to concentrate on certain sectors. For example, Carter covered healthcare stocks at Credit Suisse for five years and has continued to follow the sector since joining in 2015. Brachle, who came aboard in 2010, oversees technology.

A well-resourced, thoughtful, and disciplined steward of client assets, JPMorgan Asset Management maintains an Above Average Parent rating.

As of 2022, this investment stalwart manages more than USD 2.5 trillion in AUM. Composed of various cohorts globally and a diverse set of 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.

This fund acquired its current mandate in November 2020, but the strategy’s history dates back further to a separately managed account in place since March 2016. Since then through year-end 2020, the separate account’s annualized before-fee total returns outperformed the Russell 2500 Index prospectus benchmark and the Russell Midcap Index category benchmark by an 1.8 and 2.5 percentage points, respectively. In 2021—the mutual fund’s first full year under the current team’s leadership—the institutional shares beat both benchmarks, too. Since March 2016, top-performing holdings include pool products distributor POOL and waste management company Waste Connections. Both stocks have returned multiples of their initial investment while weathering down markets well.

Performance through the first five months of 2022 has been less impressive. The strategy normally shines in down markets, but dropped 14.4%, about a percentage point worse than both relevant benchmarks. However, the culprit was the strategy’s underweighting to energy stocks, which the managers decided in 2020 to entirely avoid. Aside from missing the energy sector’s huge upswing, portfolio holdings were generally more resilient than their sector peers as expected.

The strategy’s broader performance pattern is a close match to that of its defensive small-cap sibling, JPMorgan Small Cap Equity. The SMID separate account outperformed in a difficult 2018 and again during 2020’s coronavirus-induced bear market. Its recent underperformance fails to reflect the downside protection that investors should expect.

It’s critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category’s middle quintile. That’s not great, but based on our assessment of the fund’s People, Process and Parent pillars in the context of these fees, we think this share class will still be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Silver.