JPMorgan Equity Income A OIEIX

Lead manager Clare Hart plans to retire from JPMorgan Equity Income and the firm in fall 2024, which drives the People rating down from High to Above Average. While Hart has been essential to the strategy’s strong track record since 2004, it’s well-prepared to succeed after she retires. Until then, she remains a portfolio manager alongside Andrew Brandon and David Silberman.

In about a year, Brandon and Silberman will lead the seasoned five-person U.S. value team Hart has assembled. Brandon joined J.P. Morgan Asset Management as an equity analyst in 2000, joined this team in 2012, and became a named manager in 2019. Silberman joined J.P. Morgan Asset Management in 1989 and ran portfolios for private clients before serving as the firm’s corporate governance expert starting in 2008; he joined this team as a comanager in 2019. Dedicated analysts Tony Lee and Lerone Vincent joined the value team in 2018 and 2022, respectively. The managers will hire a veteran banking analyst within the year.

Hart and team have honed a process for two decades that doesn’t dazzle but has built stout portfolios. They seek 85-110 high-quality companies with reasonable valuations and the ability to maintain stable dividend yields of at least 2%. Their classic value philosophy says a pool of well-run but undervalued firms with reliable earnings and disciplined capital allocation will beat the market. The key is not in this perspective but in applying it with discipline, as this group has.

Since Hart became a portfolio manager in August 2004, the fund’s institutional shares have gained an annualized 9.1% through August 2023, versus 8.0% for the Russell 1000 Value Index and 7.3% for the typical large-value Morningstar Category peer. The strategy has topped rivals and the benchmark in each of the five U.S. bear markets over that stretch, often by large margins. Since Brandon and Silberman became managers, the strategy has landed between the typical peer and the index, with lower volatility.

Such a loss would often signal future mediocrity, but the well-built team and thorough approach instill confidence in this strategy, which is closed to new investors in the United States.

The search for holdings starts with a never-ending scouring of the U.S. large-value universe for companies with consistent earnings, high returns on invested capital, conservative financials, and dividend yields of at least 2%. Those dividends must also be modest payouts of firms’ earnings to ensure the funding of future business growth. The team also investigates corporate management for evidence of capital discipline.

After establishing possible targets, the team looks for stocks with relatively low valuations it believes are trading at a discount to their intrinsic values. While the team uses different metrics for various industries, it generally starts with free cash flow yield and price- and enterprise-value multiples.

The process’ output is an 85- to 110-stock portfolio. The team caps each new entrant at 5% of assets but will allow older positions to grow past that level. The portfolio maintains exposure to each of the Russell 1000 Value Index’s sectors, but relative weightings can vary by up to 10 percentage points. The team is unusually patient even within the large-value category. In the three full years since Andrew Brandon and David Silverman became portfolio managers, the strategy’s turnover ratio has averaged just 18%, lower than 90% of category peers.

The portfolio’s statistical profile conforms to the process’s principles. As of July 2023, the portfolio’s return on equity and return on invested capital (metrics measuring business quality) were 23.8% and 14.8%, much higher than the Russell 1000 Value Index’s 16.9% and 10.8%. And the portfolio’s expected long-term cash flow growth was 12.1%, dominating the bogy’s 7.3%. Yet the portfolio’s price/free cash flow ratio of 21 was below the benchmark’s 24.

To generate its returns, the portfolio neither differs markedly from its benchmark nor produces unusually high income. As of August 2023, the strategy’s tracking error (a measure of how closely a portfolio’s returns follow a benchmark’s) of 3.2% was below the typical large-value peer’s 4.0% level. And while its 1.9% income return in 2022 was above average in the category, the top quintile averaged 2.5%.

On the stock level, the key differences between the strategy and its benchmark are active weightings rather than out-of-index picks. In July 2023, just 12 of the strategy’s 86 holdings were not in the benchmark, including blue chips such as Microsoft MSFT and Starbucks SBUX. The strategy’s hallmark is material overweightings of favored index constituents. Of the seven stocks that hold at least 2% of strategy assets, six were below-1% positions in the benchmark: Only ExxonMobil XOM constituted more than 2% of the index and was overweighted.

In her 19 years as lead manager, Clare Hart built the team, refined the approach, and led the execution. So her departure will be a material loss of talent.

The rest of the value team that Hart assembled will remain, keeping an advantage over most peers. In November 2019, Andrew Brandon and David Silberman became listed portfolio managers here. Brandon started on this team in 2012 as an analyst. Silberman headed the firm’s equity investment director and corporate governance teams after managing private clients’ portfolios. They’ve worked together for four years and have complementary expertise: Brandon manages energy, materials, and industrial holdings, while Silberman manages the utilities, healthcare, telecom, and technology areas. Both have added value through stock picks since their managerial debuts.

The team now has two dedicated analysts and will soon add a third. Tony Lee joined the value team in 2018; he covers healthcare, insurance, and asset managers. Lerone Vincent joined this team in 2022, covering consumer stocks. Both came from the firm’s central analyst group. Soon the team will hire a banking expert—Hart’s core area of expertise.

This team also has access to J.P. Morgan Asset Management’s central analyst crew of 22, who average 21 years of industry experience.

This report was updated on Oct. 4, 2023, to correct Lerone Vincent's coverage.

J.P. Morgan is a well-resourced, diligent, and responsible steward of client assets. Investment teams are seasoned and stalwart, especially in equity and fixed income, the latter of which has successfully undergone substantial transformation in recent years. The firm offers competitive compensation that is aligned with fundholders and shows strong retention at senior levels of the organization. It demonstrates a culture of constant innovation and willingness to evolve. For example, J.P. Morgan recently expanded its investment committee process through which senior leaders review various teams and strategies, and it continues to develop proprietary portfolio management and risk oversight tools. Some funds still face high fee hurdles, but the firm has generally lowered expenses as it has grown.

The firm isn't without its complications. J.P. Morgan's product offering is extensive, and some areas need improvement. For instance, its multi-asset business has faced some challenges as a result of complex investment processes. The firm continues to build out its footprint in China, but its efforts there remain unproven. Although not every strategy is the best in its class, J.P. Morgan remains earnest in the pursuit of excellence, and investors are well-served.

Over lead manager Clare Hart’s tenure thus far from August 2004 through August 2023, the fund’s institutional shares rose an annualized 9.1% versus 8.0% for the Russell 1000 Value Index category benchmark and 7.3% for the typical large-value category peer. For the shorter but crucial period after Andrew Brandon and David Silberman became portfolio managers in November 2019, the strategy’s 8.1% annualized return sat between the benchmark’s 7.8% and typical rival’s 8.3% gains.

More granular data suggests that the new comanagers have boosted returns through stock-picking. Attribution from both J.P. Morgan and Morningstar from November 2019 through August 2023 shows materially beneficial stock-picking in Brandon’s energy, materials, and industrial areas as well as Silberman’s utilities, healthcare, telecom, and technology sectors. Indeed, technology had the portfolio’s best stock selection from names such as Analog Devices Inc. ADI and Apple AAPL.

On Hart’s watch, the strategy’s hallmark has been solid defense in bear markets. The S&P 500 has had five drops of at least 20% since 2004. During those, the Russell 1000 Value Index’s average fall was 32% and the typical category peer’s average drop was 31%. This strategy’s institutional shares slid an average of 27%—materially better.

Altogether, while the strategy will likely slow its pace when Hart steps down, it will probably stay ahead of the pack.

Based on our assessment of the fund’s People, Process, and Parent Pillars in the context of these expenses, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Medalist Rating of Silver.