JPMorgan: Invest in the heart of America – the case for US smaller companies, part 1

Investing in smaller companies has historically generated higher long-term returns than in larger companies. This “size premium” has been shown to exist in several important academic studies over the years, which have examined decades of financial market data[1].

Smaller company outperformance doesn’t come in a straight line, however. There have been long periods in the past in which they have underperformed larger companies, including in the US in recent years. In this article, the first in a two-part series, we look at the reasons why smaller companies tend to outperform in the long run, with specific reference to the attractively deep and diverse US small cap market and the opportunity that likely lies ahead for the JPMorgan US Smaller Companies Investment Trust plc.

Why small caps outperform in the long run

Unlike large, established companies, smaller companies have a longer runway of growth ahead of them. From a smaller starting size, they can expand faster and for longer than larger companies, which have typically already experienced the higher growth phase of their life cycle.

The mathematics here are simple – it is easier for a smaller company with a market capitalisation of, say, $5bn to deliver $500m of additional annual sales for a growth rate of 10%, than it is for a company with a market capitalisation of $500bn to produce the same rate of growth. The larger company in this example, would need to find $50bn of additional sales to deliver 10% growth. This is not an impossible task, but it is clearly a more challenging prospect for a large business to sustain high rates of growth than it is for a smaller company.

In addition to their growth advantage, smaller companies are typically less well researched than large caps, which leads to the prospect of greater valuation anomalies. With limited analyst coverage, the attractions of smaller company stocks sometimes go unnoticed by the wider market, allowing experienced investors to uncover undervalued opportunities before they are widely recognised. This less efficient pricing environment we believe makes small caps a fertile landscape for active managers and positions them for substantial potential returns over the long term.

Why US small caps?

For a long time, the United States has possessed a very attractive small cap sector, in large part because of its dynamic culture of innovation and growth. US companies are born into a corporate environment that values entrepreneurship and creativity. The successes of the past have allowed it to build a supportive business ecosystem that is adept at providing the ingredients that smaller companies need to fulfil their long-term potential. These smaller companies are, in a sense, the beating heart of American economic progress, representing the country’s drive and adaptability, and playing a key role in its long-term economic success.

Furthermore, US smaller companies tend to be more focused on domestic markets, making them less vulnerable to international trade tensions, currency fluctuations and broader global economic headwinds. This domestic orientation means they are well-placed to benefit from momentum within the US economy and other structural shifts, such as recent initiatives aimed at bringing manufacturing back to the US. Programs like the CHIPS Act and federal spending on infrastructure are directing billions into US-based industries, creating a supportive backdrop for smaller American companies involved in sectors such as technology, manufacturing and logistics.

 

Performance

Past performance is not a reliable indicator of current and future results.

Source: J.P. Morgan Asset Management/Morningstar. 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.

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.

Where permitted, a Company may invest in other investment funds that utilise gearing (borrowing) which will exaggerate market movements both up and down.

This Company may use derivatives for investment purposes or for efficient portfolio management.

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.

Compliance ID 09lr241411152132

Article tags United States Investment Trust Insights