In 2016, JPMorgan American’s board visited the Manager’s offices in New York where it held meetings with the Investment Management team to include both Garrett Fish and the manager of the small companies portfolio, Eytan Shapiro. The Board further met with senior management, the behavioural finance team of which Garrett is a member, the corporate engagement and the dealing teams. The Board also attended a seminar arranged with New York University, the week after the election, and received the benefit of a wide range of economic, political and social analysis, to help put the Investment Manager’s views into context.
JPMorgan American lagged the return on the S&P500 for 2016, returning 2% less than the index in NAV terms. In share price terms things looked a bit better with a return to shareholders of 34.96% for 2016 (including a 5p dividend, up from 4p in 2015). The Board noted 2016’s underperformance and a 2.2% underperformance in 2015 and, this year, the Board commissioned a consultancy firm called Inalytics to assist the Board with its understanding of how the Investment Manager’s investment style and actions have impacted upon performance, both in terms of contributing to, and detracting from, performance returns against benchmark. Inalytics advise the trustees of large pension funds and other institutional investors and have many years’ experience of working with active managers.
The initial findings were then developed further by the Investment Manager, who completed a forensic review of his investment decisions going back over 14 years. They say that the results suggest that the Investment Manager has demonstrated considerable skill in buying shares, over a long period, and with statistical significance. However, some of the gains derived from buying shares which then outperformed, were being given away by holding on too long to shares which did not perform well or selling shares disadvantageously.
This exercise provided both the Board and Investment Manager with useful information, which they hope will assist with shaping investment behaviour going forward. They have worked with the Investment Manager to take the lessons from the findings. They also discussed the approach with the head of US equity fund management in New York. Garrett has begun to implement changes, which are likely to result in a slightly more concentrated portfolio with a greater active share, and a more ruthless approach to underperforming holdings. At the same time, the valuation bias of the portfolio has been a benefit in relative terms in more recent months.
Garrett says he built on Inalytics work by running a multi-faceted analysis of the purchasing and selling of securities in the portfolio. The primary take aways from this analysis were that the performance of the new purchases were more beneficial than the sales of the portfolio. In order to increase the positive effect they learned that new purchases should be larger than they have in the most recent past and smaller holdings that do not rank well in their ranking methodology should be exited more quickly. Also in order to decrease the drag from the securities that have started to underperform they need to be more diligent in removing those securities from the portfolio in a more timely fashion and place the proceeds into more attractive and better performing securities. One of the end results will be a portfolio with a smaller amount of securities but these securities obviously have a higher weighting. In technical terms this adaptation will also increase the portfolio’s ‘active share’. JAM’s active share for the large cap portfolio ended the year at 67.1 and has ranged between the mid 60’s and the low 70’s over the past decade. With these enhancements they expect the active share of the large cap portfolio to be at the higher end of this range more consistently.
Performance drivers
Underperformance was mainly driven by weak stock selection in financials, energy and telecom services sectors. Within financials selling Voya Financials and Bank of America during the year had the largest negative impact on our performance in that sector. These two companies, along with many other financials, struggled to perform in a market with low interest rates.
Health care was the worst performing sector in the S&P 500 in 2016. They have several overweight positions in the sector which were negatively impacted, with the worst impact coming from Gilead Sciences and Cigna. Shares of Gilead Sciences declined on pricing pressure concerns within their US Hepatitis-C business. The company also experienced a few small setbacks in its pipeline. Volumes in Hepatitis-C have started to show some stabilisation but overall results continue to be mixed. They continue to hold the name due, to the strength of the management team, their capital allocation policies as well as the stock’s attractive valuation. Shares of Cigna struggled to perform during the year as the US Department of Justice was taking a harsh view of the proposed merger between Anthem and Cigna.
In the energy sector, negative stock selection was driven by names such as Marathon Petroleum and Valero Energy. After being significant contributors in the prior year, both securities were hurt by the recovery in the oil price during the year. Their input costs (crude oil) rose more quickly than their selling prices of refined products (diesel, petrol, jet fuel) which hurt their margins and earnings. On the other hand, stock selection in the information technology, consumer discretionary and consumer staples sectors proved beneficial. Within information technology, overweight positions in Qualcomm, Hewlett Packard Enterprise and HP Inc. were among the largest contributors. Shares of Qualcomm rose due to a widely anticipated accretive buyout of NXP Semiconductors. Hewlett Packard Enterprise and HP Inc. rose sharply during the year after the two companies split from the old Hewlett Packard. The management teams were newly reinvigorated to cost cuts and to position both companies onto a growth trajectory. They have very large positions in both Microsoft and Apple and both companies marginally beat the benchmark during the calendar year. They believe that both companies are positioned for success in some of the faster growing areas of technology and are trading at reasonable prices.
In the consumer discretionary sector, shares of an overweight position in Time Warner rose after AT&T offered to acquire the company. In the consumer staples space, investments in Tyson Foods and Energizer Holdings proved beneficial. Shares in Tyson Foods outperformed for the year as the positive impact from their Hillshire Farms acquisition began to pay off in improved margins and faster growth. Their results were further aided by lowered input costs due to the ample supplies of grain. A position in Wal Mart Stores also added to performance as it has started to reap the benefits of it prior year’s investments into increasing its online presence and its renewed commitment to having the lowest prices for its customers.
Among individual names, overweight positions in UGI and Northrop Grumman contributed to relative performance. In 2016, UGI continued to execute on its strategy to drive core gas utility growth and make opportunistic acquisitions and investments at attractive returns. Earnings reports were solid throughout the year driven by better international propane performance and growth at the US gas utility. Northrup Grumman continued its strong performance in 2016 as prior contract wins and disciplined expense management contributed to continued strong earnings, cash flow and dividend growth. Several large contract wins from the US and foreign governments during the year also contributed to the share price performance. Research and development costs will now begin to increase to support these long term contracts.
JAM : JPMorgan American board and manager revamp investment process