Use JPMorgan UK Small Cap Growth and Income to purchase UK small caps

As sentiment toward small caps improves, investing in the JPMorgan UK Small Cap Growth & Income trust is a wise move

If you want to play the recovery in UK small caps and earn an attractive income, JPMorgan UK Small Cap Growth & Income (LSE: JUGI) is a worthwhile option. For the better part of the last ten years, UK stocks of all sizes have appeared inexpensive when compared to the rest of the world. But in recent years, there have been two developments that have drastically changed the narrative in favor of investors.

The first has been the demand for UK businesses to be acquired by trade buyers and private equity. Low valuations and excess capital in the private equity markets are the cause of this, and the rate of take-outs is only getting faster.

Businesses' readiness to reimburse investors has been the second. Due to pressure from their boards and investors and a lack of other attractive investment opportunities, management has poured free cash into buybacks, making the UK market the global hub for share buybacks.

Dividends are paid on the JPMorgan UK Small Cap Growth & Income trust.

One of several JPMorgan-managed trusts, the 500 million JPMorgan UK Small Cap Growth & Income trust was established in 2024 through the merger of JPMorgan's small and mid-cap trusts. The trust's top holding, Premier Foods, will receive an annual dividend based on a percentage of the trust's net asset value (NAV), not on income from its holdings.

With funding from both capital and income, the trust aims for total annual dividends of at least 4% of NAV (based on NAV at the end of the previous fiscal year on July 31). For instance, the trust reported NAV of 373.1p for the year ending July 31, 2026, an increase of about 10p. Therefore, it suggests paying dividends of 3.73p per share every quarter for the current year, which ends on July 31, 2027, for a total of 14.9p. That amounts to a 4.1% yield on the current 364p price.

This strategy makes a lot of sense in the context of small and mid-cap firms, where the underlying companies should prioritize growth through reinvestment over shareholder returns. Georgina Brittain and Katen Patel, the managers, have much more freedom to invest where they see growth rather than just income.

This strategy also requires managers to top-slice their holdings and book the profit, which is subsequently given back to investors. A portion of the market-timing risk associated with active management is eliminated by an automatic approach to profit-taking.

The value of JPMorgan UK Small Cap Growth & Income is incredibly low.

However, the portfolio is also significantly undervalued and should provide opportunities for capital gains, so income is just one aspect of the appeal.

According to Brittain, the trust's portfolio of about 80 stocks is trading at a forward price/earnings ratio of about 11, whereas the Deutsche Numis Smaller Companies plus AIM index is trading at 13. Approximately 9% is the free cash flow rate.

Finding the most lucrative small and medium-sized businesses in the UK with the greatest potential for both domestic and international expansion is the team's main goal. One of their primary metrics for identifying the most productive companies is return on invested capital, or Roic. At five percent of the portfolio, Premier Foods, the company behind the Mr. Kipling cake brand, is the largest holding.

Gearing is also used by JPMorgan UK Small Cap Growth & Income, where borrowing averages about 10% of NAV, a level the managers consider comfortable considering the portfolio's liquidity. Therefore, income, growth, valuation, and gearing are the four levers that can contribute to value creation. Additionally, investors can currently purchase the underlying portfolio at a double discount because the trust is still trading at a modest discount to NAV (5 percent, down from over 10 percent earlier this year).

Despite the challenges that have hindered UK equities over the last ten years, the shares have generated a robust annual total return of 11.9 percent as opposed to the benchmark's 5.9 percent. The trust seems ready to continue delivering for investors as these headwinds turn into tailwinds.