JPMorgan Smaller Companies has published its results for the year ended 31 July 2016. The total return on net assets before dilution was -7.7% (-6.4% after dilution), which compares with +2.1% for the benchmark index. The return to shareholders was -10.1% reflecting a widening of the share price discount to diluted net asset value from 17.0% to 20.5%. The Directors are recommending a final dividend of 18.3p per share, 66.4% higher than the 11.0p paid last year.
Investing more in AIM
The Board, in conjunction with the Manager, has conducted a review of strategy and the market environment in which the fund operates. The Board believes that it is in shareholders’ best interests to retain the clear focus on smaller companies. However, there has been a significant contraction in the number of constituents of the benchmark index. This has fallen by 70% from 476 in 1995 to 143 today. By contrast, The AIM market has grown considerably in both size and quality, and is now larger than the benchmark index. The overall market capitalisation of the AIM index is now GBP70 billion, compared to GBP45 billion for FTSE Small Cap Index (excluding investment trusts). In order to retain the focus on smaller companies and provide a greater range of investment opportunities for the Manager, the Board has proposed that the Company’s overall investment limit on stocks admitted to trading on the AIM market should be increased from 20% to 50%. The benchmark for the Company will remain the same, but will be reviewed periodically to ensure that it remains appropriate.
Explaining the company’s performance
The manager’s report explains the reasons for the fund’s underperformance – we have reproduced part of the report here: “As we have stated over the last few years, your Company’s portfolio has been positioned to benefit from the strength of the UK economy and in particular the resurgence of the UK consumer. This positioning was reflected in the strong outperformance by your Company in the prior year. As we approached the EU Referendum, we continued to be largely consumer facing, as we deliberately chose to retain the majority of our large and high conviction positions. We did a significant amount of work in preparation for the changes that might be needed, dependent on the outcome of the vote. We also made certain changes before the vote, including increasing our investment in a number of more international businesses such as James Fisher (specialist services provider to the marine industry), Tyman (an international supplier of building products), De La Rue (the bank note printer), and Quarto (a publishing business), in addition to reducing our gearing level. These changes were not sufficient to avoid a significant, and in our view excessive, hit to share prices in a number of our consumer facing holdings in the immediate aftermath of the vote. However, it should be noted that subsequently there has been a significant rebound in many of these companies’ share prices.
In addition to the hit to performance from the referendum outcome, over the second half of the year our style-based approach to stock selection struggled. As a reminder to investors of the process by which we manage money, we focus on three key factors when we make our stock selection decisions. These are valuation, including the free cash flow a company produces after all essential costs; momentum, focusing in particular on companies which consistently beat market expectations; and quality, which focuses on a number of measures such as the return a company makes from the net assets it employs. We also consider the state of the balance sheet.
We have utilised this investment process for many years and the long term performance of the Company has been built upon this process. In the first four months of 2016, none of these metrics worked. Over the course of 2015 and early 2016, approximately one third of our portfolio holdings were promoted through share price rises into the FTSE 250 Index. They were replaced in the Small Cap index by a number of distressed commodity and oil exploration companies. We use the word distressed advisedly – these were in the main highly indebted companies with little or no free cash flow, and declining earnings. One example was the demotion of Lonmin, a platinum miner, which not so long ago was a constituent of the FTSE 100 index. These are the types of investment we actively seek to avoid; but in the first half of 2016 there was a huge rebound in the share prices of a number of these companies – and by not owning a number of them we underperformed relative to the index.”
Shareholders get to vote on the proposal at the AGM.
JMI : JPMorgan Small Cap wants to invest more in AIM stocks