JP Morgan’s stewardship of capital depends largely on whether it can maintain a focus on fundholders amid a corporate setting that is focused on profits and share price. Management, in an effort to meet profit goals, could resort to some short-term fix that would negatively affect long-term investors. What’s more, JP Morgan has been pieced together by large mergers and acquisitions, so its cultural silos could prevent the firm’s best ideas from working their way through the entire fund complex.Morningstar has found, however, that JP Morgan is making its best effort to be a role model for a bank-run fund family–and a formidable competitor to fund shops such as PIMCO and BlackRock. Management is strong, the overall fund lineup is decent, (especially on the fixed-income side), it has a clean regulatory history, and the compensation structure is fair. Because of that, its earns a Corporate Culture grade of B.
To understand Morningstar’s sentiment fully, it helps to know the culture at both the parent company and the Asset Management division. J.P. Morgan Chase can trace its roots back 200 years. But it’s arguably been the last decade that has had the most profound impact on the firm. In 2000, J. P. Morgan & Co. merged with Chase Manhattan Corp. Four years later the combined company swallowed up Chicago-based Bank One.
At the depths of the financial crisis, the company purchased ailing firms Bear Stearns and Washington Mutual. During that time it swelled to almost 225,000 employees from 75,000, and revenues tripled to $105 billion.
Those deals also helped shape the Asset Management division, home to JP Morgan’s Private Bank, Private Wealth Management, defined contribution and securities operations, as well as the mutual funds. Chase Manhattan owned Robert Fleming & Co., the London-based asset manager that had a big presence in Asia.
Some Fleming investment teams now oversee several JP Morgan equity funds. Bank One’s fixed-income offerings based in Columbus, Ohio, are a large anchor of JP Morgan’s bond shop. When JP Morgan bought asset-management firm Highbridge Capital Management in 2009, it helped the fund family move into alternatives such as commodities and market neutral strategies.
There are both positives and negatives to JP Morgan’s structure. One significant attribute is squarely at the top: management. Jamie Dimon, who was catapulted to the CEO spot in the wake of the Bank One deal, has deftly navigated the firm in his five years at the helm. Under Dimon’s watch, JP Morgan’s profits have doubled, and its fortified balance sheet helped it weather the downturn better than competitors. A testament to that is the fact JP Morgan pulled off the Bear Stearns and WaMu deals when the financial system seemed on the brink of collapse. rumours in the press say JP Morgan may even start to increase its dividend payment in 2011.
The $1.8 trillion Asset Management division is run by Mary Callahan Erdoes, a 15-year company veteran and Harvard MBA who previously headed the private bank, among other roles, before taking on her current duties in 2009. A key Erdoes’ lieutenant is George Gatch, a 25-year company veteran who helped launch the fund family and now has the title of head of Investment Management Americas. At the investing level, key executives’ average tenure exceeds 10 years.
Erdoes and Gatch are riding a winning horse. Although a few fixed-income funds in the New York office are glaring exceptions, JP Morgan funds on average held up better than the competition in 2008’s market slide. The funds are risk-aware overall, which fits with JP Morgan’s legacy running private wealth and has resonated especially well with advisors eager to protect their clients’ portfolios. Since the beginning of 2009, the fund family has seen $46 billion in net inflows–some of the strongest flows in the fund world. The firm’s 100-plus funds now hold around $121 billion. And Erdoes’ asset management division accounts for around 10% of the parent company’s profits–and that percentage could increase.
Management, of course, is beholden to both internal and external expectations. The parent company is measured, in large part, by whether it beats Wall Street earnings estimates. To meet those numbers, each division must hit theirs, too. Press reports have said that Erdoes would like to double net income over the next five years. JP Morgan has told Morningstar that goal is aspiration and not set in stone.
Ordinarily, such a pronouncement would turn heads, but Morningstar is comfortable with JP Morgan’s goal for several reasons. First, it’s a divisionwide objective, which means Erdoes has plenty of options to meet it, including growing the private bank and wealth-management businesses. The full brunt of that goal wouldn’t fall on the fund complex.
In addition, management seems to have taken off the table aggressive moves that would raise red flags. When it comes to growing a mutual fund complex’s bottom line, executives primarily have four tactics: cut costs, raise fees, launch new products that attract inflows, or build out the capacity of the existing lineup. To its credit, JP Morgan funds kept its research budget intact during the downturn. It was opportunistic about hiring during that time, scooping up analysts with deep experience. Management also has a track record of lowering fees. It reduced annual expense ratios during the Bank One merger and dropped fees on 13 and 11 funds in 2009 and 2010, respectively. Most funds charge below-average annual expenses.
Two areas where management has placed an emphasis are new products and building out capacity. JP Morgan has launched 59 funds since 2005. Those launches include a target-date series and country funds focused on China, India, and the Latin America region–all relative standards at other fund companies. JP Morgan has been more innovative with 130/30 funds, an inflation-managed bond fund, and an absolute return strategy.
While JP Morgan gets credit for innovation, the specialty funds are of questionable use to a large swath of retail clients. Most investors have a difficult time using these types of funds effectively as evidenced by investor returns–a dollar-weighted measurement of the average investor fared in a particular fund. Overall, JP Morgan funds have a decent record when it comes to trailing three-year investor returns. Some of the newer funds, though, are in the bottom decile of their categories. To its credit, JP Morgan devotes resources to educating its clients on these funds. It has 95 client portfolio managers–an almost one-for-one ratio with each fund in the lineup–who are available to answer advisors’ questions about the investments. At competitors, that ratio is more like one client manager for every four or five funds.
JP Morgan certainly has room to attract more assets to many of its existing retail funds. The firm has ample capacity in its retail large-cap strategies as well as its diversified foreign products. There is plenty of capacity on the fixed-income side, too.
But there is a delicate balance to asset gathering. Indeed, when JP Morgan revs up its marketing and distribution arms, it’s a well-oiled machine. The process has many components. Advisors receive a weekly e-mail describing the firm’s market outlook. That e-mail teases webinars and conference calls with experts such as chief market strategist Dr. David Kelly that can draw thousands of viewers and listeners. The sales staff’s pitches tie in with the firm’s market outlook as well.
To see how effective that process is, consider JPMorgan Strategic Income Opportunities (JSOAX), a complex absolute return fund launched in October 2008. The offering has grown to a staggering $11 billion. At one point, manager Bill Eigen was dealing with inflows of $100 million a day. The firm had to stop actively marketing the new fund to stem the tide of cash. Eigen’s fund had a solid 2009, returning almost 19%, and gained 5% in 2010. Unfortunately, most of the money flowed in after 2009’s big gain, so the fund’s cash-weighted investor returns in 2010 are in the bottom 15% of its category.
Of course, a fund company can launch all the new funds it can or attract billions of dollars in assets, but without the talent to run that money, the effort is futile. JP Morgan’s investment and research operations are areas where Morningstar sees considerable strengths–and potential concerns.
JP Morgan’s research operation is backed by a $100 million-plus budget. At its core are nearly 300 analysts who average over a decade worth of experience. (JP Morgan prefers seasoned researchers over recent MBAs.) Every morning at 8:30 a.m., the traders, analysts, and portfolio managers conduct a quick premarket meeting on stock upgrades or downgrades–anything new that would affect a security. At 4 p.m. the chief investment officer or the director of research holds a meeting where an analyst reviews her given sector with U.S. large-cap managers. During the course of any week there are so-called “Bull and Bear” sessions where the upside and downside of a particular stock is put under a microscope. All notes about a stock or bond are housed in an electronic database. On this platform, JP Morgan funds’ investment staff can find earnings projections, notes on recent company visits, the valuation model, a short investment thesis. and other crucial details. The analysts’ best ideas are reflected within an internal research fund.
This research process provides JP Morgan funds with a key edge on the competition. For example, the large-cap core analyst recommendations outperformed their benchmark by 1.6 percentage points annually since 1997. That performance can be seen in funds that rely heavily on this research. JPMorgan U.S. Equity (JUEAX), JPMorgan US Large Cap Core Plus (JLCAX), and JPMorgan Research Market Neutral (JMNAX), are all in the top 40% of their categories over the trailing three- and five-year time periods–with US Large Cap Core Plus in the top decile during those time periods.
But when the larger return picture is taken into context, there seems to be a disconnect. Top decile-performing funds are the exception at this fund family, not the norm. There are several reasons why this may be so. First, JP Morgan has a firmwide focus on risk. That focus is designed to shelter JP Morgan funds from blowups in a downturn, but it also prevents the funds from shifting into overdrive during rallies. The end result are returns that may look decent on an absolute basis but finish just ahead of the category average.
The so-so performance also could be tied to manager decisions–whether good or bad. JP Morgan fund managers are just as capable of making a bad call as any other manager, regardless of the resources backing them up. Indeed, JPMorgan Asia Equity (JAEAX) touts the fact it can tap 12 regional and 53 country specialists for research information. But the fund is firmly in the category’s midzone during the trailing three- and five-year time periods. It’s not a big leap to expect better results with that many boots on the ground.
What is unclear, though, is how much of the middling performance can be attributed to offices or managers creating silos around themselves and their staffs, selectively using the research or not sharing their insights across the entire firm. The mergers of the last decade mean JP Morgan’s fixed-income operations are now dispersed in offices in Columbus, Ohio; Cincinnati; Indianapolis; Boston; New York; and overseas. While the equity operations are grounded in New York, it, too, has staffs across the globe.
To its credit, management has taken a hands-off approach to running these offices. Instead of forcing them to move to a centralized location, the individual staffs are given the resources they need to sustain themselves. An overarching investment committee structure tries to ensure consistent performance and to put out any performance fires before they get out of control. But in a company this size, it’s not out of the realm of possibility to expect a few teams to stay on their own turfs or to outright compete against each other.
One area where JP Morgan is a clear standout is with its board. Eleven of the 13 trustees are considered independent, and the board is led by an independent chairman, Fergus Reid III. The independent trustees also invest heavily in the funds they monitor. Morningstar looks to see whether trustees invest as much in the funds as they make in compensation during a single year because such investments signal that the trustees’ own financial incentives are aligned with long-term shareholders’. A recent SEC filing states the members starts at a base pay of $220,000, and each trustee has over $100,000 invested in the fund complex–the maximum range disclosure required by the SEC. Because of those levels, the board receives full credit for fund ownership.
But the board’s merits don’t stem solely from its members’ wallets. It has a rich and varied background in the mutual fund and financial worlds. In addition, as the fund family has launched innovative new products such as the absolute return fund Strategic Income Opportunities, the board has adapted in order to better analyse those new funds (59 since 2005). For example, the board has traditionally been shaped around four committees: audit and valuation, compliance, governance, and investments. Recently, though, the board added equity, fixed-income and money market and alternative products subcommittees. These subcommittees monitor fund performance, portfolio risk, inflows and trading practices. Any new fund is pitched by management to the subcommittee and to the entire board. The board’s experience and structure give Morningstar confidence that the fund family will launch products that are sound, both from a strategy and cost standpoint.
The board also receives high marks for the way it monitors the fund lineup during the course of the year. Instead of getting performance attribution statistics from the fund company or fund manager–a method that could lead to selective disclosure–the board works with independent consulting firm Casey Quirk. This firm reports to the trustees on fees, funds’ operational statistics and their relative and absolute performance numbers. The board also monitors a watch list of funds that have had significant inflows and outflows of cash or a manager change, or have unique strategies or high fees compared with competitors. This setup gives the board adequate information to make key decisions.
JP Morgan and the board also have proactively reduced fund fees. The firm did so during the Bank One merger earlier the last decade, and it has reduced fees on 13 offerings in 2009 and 11 in 2010. (Together, those cuts affected about a fourth of the fund family’s offerings.) Most JP Morgan funds sport annual expense ratios that are below their category averages.
Given that backdrop, it is interesting to see how the board has handled asset inflows and fund closings. Up until 2009, JP Morgan didn’t have a problem with rapid inflows of cash. It received its fair share of inflows, but in smaller amounts, spread throughout the fund lineup. In the last two years, though, $46 billion has flowed into the fund complex, with an astounding 22% of that money heading into the coffers of the newly launched Strategic Income Opportunities. At one point, manager Bill Eigen was dealing with daily injections of $100 million. That amount can be daunting for a seasoned, large-cap fund that can handle capacity. It’s even more so for a new, unproven one. JP Morgan could have closed the fund to new investors. Instead, it told its sales network to stop selling the fund. That tactic worked–the fund’s assets have leveled off. But it brings up a debate about which is the more shareholder-friendly method of turning off the spigot. JP Morgan argues it has several tools it can use–cut back on marketing the fund, implement a soft close, or raise the minimum–that attain the same goal as a hard close. It’s a fair point, but this is an area to keep an eye on in the future.
In the end, JP Morgan’s focus on generating returns with limited risk is intentional, and the firm has executed well on that goal. It is a long-held strategy versus reverting to some kind of a survival tactic. The fund family has capable talent, a decent lineup that is getting stronger, a tendency to keep fees low, and a clean regulatory history.
Rob Wherry is a mutual fund analyst with Morningstar.This post originally appeared at Morningstar.
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