Invest in the heart of America
June 2024
This is marketing communication
Investors are frequently told about the benefits of diversification, but sometimes market conditions can lead to returns becoming increasingly driven by a narrow band of stocks. This has clearly been the case in recent years, with large US technology companies dominating equity market performance, at times leaving practically everything else in their wake. Indeed, seven stocks – termed “The Magnificent Seven”1 by the media – delivered almost 70% of the entire total return from the S&P 500 Index in 20232. As a result of their outperformance, these seven stocks account for almost 30% of the entire index, making the US stock market more concentrated than it has been since at least the early 1970s3. This means less diversification for investors which, in theory, translates into more risk.
An opportunity to diversify
Although the action has clearly been elsewhere, there is an appealing alternative option for investors that would prefer a more diversified approach to the US stock market. It is often the case that, when markets become as concentrated as this, there will be another part of the market that is being overlooked by investors. Relative valuations suggest that, in current market conditions, it is US smaller companies that have been out of favour with investors.
This is evidenced in the graphic below, which shows that the collective market capitalisation of the entire Russell 2000 Index – a benchmark that has become known as a bellwether of the US economy by measuring the performance of around 2,000 of the smallest listed US companies – is currently smaller than that of the largest single stock in the US, Microsoft.
This potentially indicates two things. Firstly, there is a risk of over-valuation among the large US technology companies that have dominated market returns. Secondly, by contrast, US smaller companies may now be under-valued as a result of their lack of popularity.
Over long periods of time, there is an inverse relationship between starting valuations and subsequent long-term returns. Nothing is certain in investment, but this relationship should mean that if you invest when valuations are low, future long-term returns should be high and vice versa4. This bodes well for the outlook for US smaller companies but could represent a troubling omen for the popular technology giants.
The entire Russell 2000 index currently has a market cap less than that of Microsoft. Investors are frequently told about the benefits of diversification, but you currently 2000 US smaller companies for less than the price of one large one.5
Lessons from history
History also supports this notion. The chart below highlights that the previous occasions in which the US stock market has become over-concentrated in a narrow band of stocks (signified by the red dots on the green line) were the early 1970s in what was known as the “Nifty Fifty” market, and early 2000s during the infamous dotcom bubble.
It is noteworthy that US smaller companies enjoyed a prolonged period of outperformance in the aftermath of these events, as indicated by the rising blue line from 1973 to 1984 and 2000 to 2011.
Historically, small caps have outperformed large caps when index concentration has reached these levels
Source: J.P. Morgan Asset Management, Frank Russell Company, Furey Research, Factset. Factset data as of 02/29/2024. Furey Research as of 02/29/2024. The securities above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell. Past performance is not a reliable indicator of current and future results.
History suggests, therefore, that this could be an appropriate time for investors to consider allocating away from the global-facing US technology giants, and towards US smaller companies.
The broad attractions of US smaller companies…
Why invest in the Magnificent Seven, when you can have the Magnificent 2000 instead? As well as offering greater diversification benefits, US smaller companies offer several other attractions. Smaller companies tend to outperform in the long run, by virtue of the longer runway of growth that lies ahead of them6.
Meanwhile, the US smaller company sector is renowned as one of the deepest market opportunities available anywhere in the world. Indeed, America’s historic economic success should, at least in part, be attributed to the diversity and entrepreneurialism of its thriving smaller company sector, which represents the real heart of corporate America.
…Coupled with the selective abilities of an experienced team
While broad exposure to US smaller companies may make sense for all the reasons outlined above, there is potentially an even greater opportunity for expert professional investors to capture.
It should be remembered that smaller companies carry a higher risk profile. Higher risk could offer the chance of higher returns over time, but it can also make individual smaller company share prices more volatile. This additional risk can be effectively mitigated through a sensible level of diversification and careful stock selection.
The team behind the JPMorgan US Smaller Companies Investment Trust (JUSC) consistently focuses on company quality as a defence against this volatility. More than a third of companies in the Russell 2000 Index are unprofitable, which tends to lead to even higher levels of volatility, particularly when equity markets suffer a setback7. The JUSC team’s disciplined focus on quality means many of these unprofitable smaller US companies are not considered for investment in the portfolio. Not that it’s a guarantee for the future but historically, this has allowed JUSC to deliver outperformance of the Russell 2000 Index alongside lower relative volatility and less downside risk.
JUSC - a quality portfolio at an attrative valuation with good earnings growth
Source: J.P. Morgan Asset Management, Favtset as of 31 March 2024. The portfolio is actively managed. Holdings, sector weights, allocations and leverage, as applicable, are subject to change at the descretion of the investment manager without notice
The JUSC investment team is led by Don San Jose who has been managing the portfolio successfully for the last 16 years. Selecting largely from within the Russell 2000 Index, Don and his team have built a portfolio with some other very attractive financial characteristics, which tilt the odds of long-term success even further in favour of the Trust’s shareholders.
As well as offering higher quality (measured in the chart above by return on equity) than that of the index as a whole, the JUSC portfolio also has a lower valuation and offers faster potential growth.
Little wonder, therefore, that the team is confident that investing in the heart of America in a portfolio with these characteristics, should serve investors well in the years ahead.
Find out more about JPMorgan US Smaller Companies Investment Trust plc
Performance
Past performance is not a reliable indicator of current and future results.
Source: J.P. Morgan Asset Management/Morningstar as at May 2024. Net asset value performance (NAV) data has been calculated on a NAV to NAV basis, including ongoing charges and any applicable fees, with any income reinvested, in GBP.
NAV is the cum income NAV with debt at fair value, diluted for treasury and/or subscription shares if applicable, with any income reinvested. Share price performance figures are calculated on a mid market basis in GBP with income reinvested on the ex-dividend date. The performance of the company's portfolio, or NAV performance, is not the same as share price performance and shareholders may not realise returns which are the same as NAV performance.
Benchmark source: Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell© is a trademark of Russell Investment Group.
Comparison of the Company's performance is made with the benchmark. The benchmark is a recognised index of stocks which should not be taken as wholly representative of the Company's investment universe. The Company's investment strategy does not follow or track this index and therefore there may be a degree of divergence between its performance and that of the Company.
1 The Magnificent Seven stocks are Apple, Microsoft, Alphabet (Google), Amazon, Nvidia, Meta (Facebook) and Tesla.
2 Source: Forbes to 31 December 2023.
3 Source: J.P. Morgan Asset Management, Frank Russell Company, Furey Research, Factset to 29 February 2024, based on the concentration of the largest seven stocks in the S&P 500 Index as a % of total market cap.
4 Several academic studies have demonstrated the inverse relationship between starting valuation and subsequent long-term returns, including "The Cross-Section of Expected Stock Returns" by Fama & French (1992) and "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors" by Campbell & Shiller (1988).
5 Source: Bloomberg as of 14 March 2024. The securities shown are for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell.
6 Over the years, several academic studies have examined the long-term outperformance of smaller companies, including "Murphy's Law and Market Anomalies" by Dimson & Marsh (1999) and "Common Risk Factors in the Returns on Stocks and Bonds" by Fama & French (1993).
7 Source: Furey Research as of 29 February 2024. Past performance is not a reliable indicator of current and future results.
Disclosures
Summary Risk Indicator:
The risk indicator assumes you keep the product for 5 year(s). The risk of the product may be significantly higher if held for less than the recommended holding period.
Investment objective:
The Company aims to provide investors with capital growth by investing in US smaller companies that have a sustainable financial competitive advantage. As the emphasis is on capital growth rather than income, shareholders should expect the dividend to vary from year to year. The Company focuses on owning equity stakes in businesses that the manager believes trade at a discount to intrinsic value, with strong management teams. The Company has the ability to use borrowing to gear the portfolio within a range of 5% net cash to 15% of net assets. Gearing may magnify gains or losses experienced by the Company.
Risk Profile:
Exchange rate changes may cause the value of underlying overseas investments to go down as well as up.
External factors may cause an entire asset class to decline in value. Prices and values of all shares or all bonds and income could decline at the same time, or fluctuate in response to the performance of individual companies and general market conditions.
This Company may utilise gearing (borrowing) which will exaggerate market movements both up and down.
This Company invests in smaller companies which may increase its risk profile.
The share price may trade at a discount to the Net Asset Value of the Company.
The single market in which the Company primarily invests, in this case US, may be subject to particular political and economic risks and, as a result, the Company may be more volatile than more broadly diversified companies.
This is a marketing communication and as such the views contained herein do not form part of an offer, nor are they to be taken as advice or a recommendation, to buy or sell any investment or interest thereto. Reliance upon information in this material is at the sole discretion of the reader. Any research in this document has been obtained and may have been acted upon by J.P. Morgan Asset Management for its own purpose. The results of such research are being made available as additional information and do not necessarily reflect the views of J.P. Morgan Asset Management. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all inclusive and are not guaranteed as to accuracy. They may be subject to change without reference or notification to you. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Changes in exchange rates may have an adverse effect on the value, price or income of the products or underlying overseas investments. Past performance and yield are not reliable indicators of current and future results. There is no guarantee that any forecast made will come to pass. Furthermore, whilst it is the intention to achieve the investment objective of the investment products, there can be no assurance that those objectives will be met. J.P. Morgan Asset Management is the brand name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. To the extent permitted by applicable law, we may record telephone calls and monitor electronic communications to comply with our legal and regulatory obligations and internal policies. Personal data will be collected, stored and processed by J.P. Morgan Asset Management in accordance with our EMEA Privacy Policy www.jpmorgan.com/emea-privacy-policy. Investment is subject to documentation. The Annual Reports and Financial Statements, AIFMD art. 23 Investor Disclosure Document and PRIIPs Key Information Document can be obtained in English from JPMorgan Funds Limited or at www.jpmam.co.uk/investmenttrust. This communication is issued by JPMorgan Asset Management (UK) Limited, which is authorised and regulated in the UK by the Financial Conduct Authority. Registered in England No: 01161446. Registered address: 25 Bank Street, Canary Wharf, London E14 5JP.
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