JPMorgan European Discovery Trust aims to provide capital growth from a diversified portfolio of European small-cap companies (excluding the United Kingdom). The managers seek out ‘hidden gems’ that possess the quality, value and momentum characteristics capable of transforming these companies into tomorrow’s market leaders. The trust has almost £700m in assets and is managed by Jon Ingram, Jack Featherby and Jules Bloch of JPMorgan Asset Management, a global investment management company. This team assumed responsibility for the portfolio at the beginning of March 2024.
1. European small caps have a long history of outperformance.
European small caps have an outstanding long-term track record of outperformance of European large caps and most other markets over the 25 years since the launch of the MSCI Europe (ex UK) Small Cap Index. These dynamic companies tend to perform best in low-volatility markets and during periods of economic stability, as small businesses have less capacity to absorb market and economic shocks than their larger counterparts. So it is not surprising that the sector came under pressure during the run of highly unusual events in recent years, including 2020’s COVID-19 pandemic, Russia’s invasion of Ukraine in 2022 and last year’s rapid interest rate rises.
2. A new management team is delivering better returns.
Against this unsupportive backdrop, the trust underperformed in 2022 and 2023 due to asset allocation decisions, as it lacked exposure to energy, defence and financials – sectors that benefited from these upheavals. This underperformance prompted a strategic review and the appointment of the new management team.
Ingram and his colleagues have since made some meaningful changes to the portfolio. They have shifted the focus in favour of stock selection, from the previous approach that included more active sector and country allocation. This has led to greater portfolio diversification and lower asset allocation risk, while also playing to the strengths of the team.
For example, reductions in overweights to consumer durables and technology have allowed the managers to increase exposure to healthcare. This sector was previously the portfolio’s largest underweight, but it is an area in which many leaders have grown from small-cap origins due their ability to innovate. At the country level, overweights to France, Germany and Italy have decreased significantly, in favour of Spain, Austria, Denmark and Norway. The team has also adopted a fresh focus on micro-cap companies, where they see great opportunities overlooked and undervalued by most investors due to their lack of liquidity. These portfolio changes have significantly improved performance in absolute terms and against the benchmark during 2024, and the trust is also outpacing its peers.
3. The fundamentals for European small caps are very positive.
In the managers’ view, the prospects for the sector have rarely been brighter, and they expect the trust’s shareholders to benefit accordingly. They claim the opportunity set for alpha creation through stock selection is wider than usual, offering attractive, high- quality investment propositions in every sector.
The team’s conviction in European small caps is underpinned by the fact that several adverse influences that have weighed on the asset class in recent years are now providing support. Notably, interest rates are declining in all major markets, real wages and consumer sentiment are increasing and manufacturing activity appears to be strengthening.
4. European small caps are overdue a potentially significant rebound.
Yet valuations remain low relative to both history and European large caps. The asset class has underperformed European large caps by more than 25% in the three years since September 2021 – the longest and most extreme case of underperformance in the past 20 years.
Historically, periods of lagging returns have been followed by strong outperformance, and the worse the underperformance, the greater the subsequent rebound. While forecasting the exact timing of any market turning point is always a challenge, this pattern suggests that the asset class is set for a potentially dramatic rebound sometime soon.
Published 26 February 2025.
