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Despite Manager Departure, This Fund Remains Appealing

Silver-rated Jensen Quality Growth is losing one of its skippers, but the fund has maintained its disciplined approach--and outperformance--through other departures.

Greg Carlson, 03/13/2017

Although Jensen Quality Growth's longest-tenured manager will retire in early 2018, its prudent, consistently applied strategy and the rest of its veteran team continue to merit a Morningstar Analyst Rating of Silver. Robert Zagunis, comanager of this fund since January 1993 and the former chair of the investment committee, announced he will retire at the end of February 2018. His departure is a significant loss, but the rest of the team is experienced and stable: The other six members have worked on the team for 8-16 years. Furthermore, the fund has maintained its disciplined process and continued to outperform through the retirements of previous veterans, including firm founder Val Jensen in 2003.

This fund’s relative performance rankings can be extreme at times. It lagged its typical large-growth peer for much of the post-bear-market stock rally from early 2009 through 2015. In contrast, the fund surpassed 98% of its large-growth Morningstar Category rivals in 2016.

Both showings are consistent with the fund's strategy and risk profile. Its managers build a concentrated portfolio of 25-30 companies that have generated returns on equity of at least 15% in each of the previous 10 calendar years prior to purchase and also sport appealing valuations and future prospects. The fund tends to lag in rallies led by leveraged fare and hold up well in tougher times. Indeed, although it lost 29% in 2008's sharp market decline, the fund lost 11.7 percentage points less than its typical peer. The fund then lagged more than 75% of its peers in the rebound of 2009.

But while the team's highly disciplined approach can cause its record to look merely average at times, it has delivered a remarkably steady return stream that makes it easy to own. From Zagunis’ 1993 start through February 2017, the fund surpassed 90% of its peers, as well as the S&P 500 and the Russell 1000 Growth Index, on a risk-adjusted basis. The fund's record is similarly impressive since stocks' October 2007 peak.

Combine these positive attributes with the fund’s below-average fees, and its long-term prospects look bright.

Process Pillar: Positive | Greg Carlson 03/09/2017 
This fund's management team annually screens nearly 10,000 publicly traded companies with market caps of at least $1 billion for firms that have delivered returns on equity of at least 15% in each of the past 10 years. That whittles the pool of candidates down to fewer than 250 names. While the number of potential holdings dropped during the 2007-09 recession and bear market to around 140, it rebounded as companies' balance sheets and profitability metrics improved.

The managers analyze the companies that pass their screens to determine which ones have the best growth prospects and valuation profiles. Discounted cash flow analysis stretching out over long periods (typically a decade or more) is the primary valuation measure. But the managers also look at P/E and price/book ratios, among others, and compare them with their discounted cash flow analysis.

The fund owns just 25-30 stocks. Management aims to hold its purchases for many years. Indeed, annual portfolio turnover has averaged just 16% during the past five years.

Management will sell a holding that doesn't deliver a 15% ROE or that has diminished growth prospects. In many cases, though, the team winds up selling a holding because of concerns that only later cause it to drop out of the 15% ROE universe. This distinctive and disciplined strategy earns a Positive Process rating.

The portfolio's turnover was 14% last fiscal year, and it's very rare that two stocks are purchased or sold within the same quarter. The managers have made the portfolio slightly more diversified during the past few years; instead of owning 25 stocks, the fund will now go as high as 30. Nevertheless, it's still quite distinctive, and the holdings list was back down to 27 at the end of 2016.

The fund's stake in industrials at that point was nearly double that of the S&P 500. While some industrials are quite cyclical, the fund focuses on stable conglomerates within the sector such as United Technologies UTX and 3M MMM. Less surprising is the fund's above-average stake in consumer defensive firms. Many boast the steady revenue and cost advantages that management favors, including holdings such as PepsiCo PEP, Procter & Gamble PG, and Coca-Cola KO.

The fund's healthcare stake has rebounded to 21% (somewhat above the large-growth category norm of 16%). Once a significant overweighting here, it was trimmed in part because of the sales of holdings with weakening fundamentals, such as Stryker SYK. (The fund repurchased that stock in late 2015.) Thus, it was an area of poor performance for the fund for several years as the team grappled with the effects of healthcare reform. But recently, the team has picked several winners in the sector, such as Becton, Dickinson BDX and Johnson & Johnson JNJ.

Performance Pillar: Positive | Greg Carlson 03/09/2017 
Although it struggled a bit more than it should have for several years, the fund is showing its mettle again.

The equity rally of early 2009 to mid-2015 left this fund eating its rivals' dust at times. The fund lagged its typical large-growth peer in five of seven calendar years, lagged its S&P 500 benchmark in five of those years, and lagged the Russell 1000 Growth in every one of them, thus denting its record for periods of up to 10 years.

Because of its focus on high-quality fare, the fund tends to hold up much better in downturns, more than making up for its sluggishness in big rallies. Indeed, as stocks gyrated in early 2016, the fund outpaced nearly all of its peers in the first quarter, and it continued to outperform in the rebound that marked the rest of 2016.

The fund's long-term record remains strong. From stocks' previous peak in October 2007 through February 2017--arguably a full market cycle--the fund's risk-adjusted returns (based on Sortino and Sharpe ratios) surpassed 95% of its peers, the Morningstar Wide Moat Index, the S&P 500, and the Russell 1000 Growth Index. (The fund's returns have been a bit more correlated to those of the first two indexes during this period.) The fund's risk-adjusted returns are also strong when measured from the January 1993 start date of Robert Zagunis, the fund's longest-tenured portfolio manager. The fund earns a Positive Performance rating.

People Pillar: Positive | Greg Carlson 03/09/2017 
Robert Zagunis, who joined the firm as a manager in 1993, announced that he will retire at the end of February 2018. The departure of Zagunis should mark the end of a slow changing of the guard here: Two of the three managers who joined close to the fund's late-1992 inception have retired since the end of 2003, as has another veteran skipper. However, the firm has long been rigorous in its hiring practices, adding investment personnel who fit well within the firm's culture and hiring well in advance of retirements. Only one manager has left the firm for reasons other than retirement.

The rest of the team is deep and experienced. Eric Schoenstein, chair of the investment committee and head of research, has been a comanager since 2004 and joined the firm in 2002. Rob McIver has been a comanager since 2005 and firm president since 2007.

Kurt Havnaer joined the firm in 2005 as an analyst and has comanaged the fund since September 2007. He previously spent nine years at Columbia Investment Management. Allen Bond and Kevin Walkush each joined as analysts in 2007 and were promoted to comanagers in May 2011. Adam Calamar, who became an analyst in 2010, was named a comanager in 2013. The oldest of these six members are in their early 50s, so we wouldn't expect any more retirements in the near future. This experienced crew earns a Positive People Pillar rating.

Parent Pillar: Positive | Greg Carlson 03/31/2016 
Jensen Investment Management has generally gone about things the right way. The firm has a strong investing identity: It had just one fund (Jensen Quality Growth) for the first 18 years of its existence, and the second one--Jensen Quality Value JNVSX, launched in 2010--takes little of the investment team's time from the flagship. The latter is quantitatively driven and uses many of the same criteria as Jensen Quality Growth. The team has lost three senior managers to retirement since 2004, but only one other investment professional has ever left.

The firm also treats shareholders well. Its shareholder communications explain in detail the theses for the firm's investments. In addition, the team's very long-term approach means trading costs are minimal and taxable capital gains distributions are very infrequent.

The board for Jensen Quality Growth, composed of four independent trustees and one interested trustee, has done a pretty good job. Fees are modest at Jensen Quality Growth, but the tiny Jensen Quality Value is pricey given how little time is spent on it. Jensen Quality Growth's board is invested alongside shareholders, with more than $100,000 each in the fund. Meanwhile, Jensen Quality Value's board doesn't invest in it. Each fund has one portfolio manager with more than $1 million invested in it. All told, Jensen earns a Positive rating, with room for improvement.

Price Pillar: Positive | Greg Carlson 03/09/2017 
Fundholders get a pretty decent deal here. The fund's J shares hold 44% of the assets, charge 0.87%, and earn a Morningstar Fee Level of Average. The I shares hold 52% of assets, charge 0.63%, and earn a Below Average. The Y shares, launched in September 2016, charged 0.55% in their prospectus (there's no annual report figure yet for this class) and would earn a Low. The R shares hold less than 1% of assets, charge 1.22%, and also earn a Below Average.

Low portfolio turnover has meant minimal brokerage costs here over the long haul, too. The fund earns a Positive Price Pillar rating.

 

Greg Carlson is a fund analyst with Morningstar.

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