A Terrific Large Growth Fund

The following is our latest Fund Analyst Report for Jensen Quality Growth JENSX. Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

A solid team, process, and culture support a Morningstar Analyst Rating of Silver for most of Jensen Quality Growth's share classes.

Experienced managers who know and stick to this strategy's strengths run this show. Six managers with an average of more than 25 years in the industry and 13 years at Jensen Investment Management work as a team. They understand that the process' forte is selecting attractively priced stocks from a well-vetted universe of consistently profitable companies. The squad has stayed within this circle of competence across market cycles and generational changes among its members.

The approach is deceptively rote. It screens for companies with market caps of more than $1 billion that have generated returns on equity of at least 15% in each of the previous 10 calendar years and buys those that still look good after examining their business models, growth opportunities, market positions, and more.

It's possible to isolate and build a portfolio of stocks exhibiting such quality attributes with an algorithm, but this strategy differentiates itself from the many rival exchange-traded funds that have emerged in recent years with focus, attention to valuation, and low turnover. The strategy buys and holds 20 to 25 stocks trading below the managers' estimates of intrinsic value, informed by a conservative, three-stage discounted cash flow model. That leads it to consistent and enduring rather than high-flying growth stocks at modest valuations. Such holdings tend to lag in more fervid growth markets but make up ground on the downside. Indeed, the fund's results, even when it lags, look better on a risk-adjusted basis.

Though many cheap strategic-beta funds tracking the same profitability and volatility characteristics have emerged, this strategy's managers have demonstrated stock-picking acumen over a long period of time. The firm's primary focus on one strategy, below-average fees, high retention, and consistent culture combine to serve investors well.

Process | Above Average This fund's deliberate and distinctive strategy deserves an Above Average Process rating.

The process starts simply. The managers here screen for companies with market caps of at least $1 billion that have delivered returns on equity of at least 15% in each of the past 10 calendar years. That reduces its pool of candidates to fewer than 250 stocks.

The approach isn't mechanical, though. Anyone with a decent stock database can derive a similar universe of profitable stocks, but these managers don't stop there. They scour companies that pass the initial screens for those that have the most-durable competitive advantages, best cash flow growth prospects, most-shareholder-friendly capital-allocation practices, and most-attractive valuations. The team uses discounted cash flow analysis stretching out over long periods as its primary valuation tool but also considers other metrics, such as P/E and price/book ratios.

The portfolio is focused and long-term. It owns just 25-30 stocks, often for seven to 10 years. The team collaborates on buy and sell decisions, researching each idea until it reaches consensus. Selling is a team decision, too. The fund sells stocks when their returns on equity drop below 15% or shows diminished growth prospects. It will also sell if it discerns a better opportunity elsewhere.

This concentrated fund doesn’t look like its typical large-growth Morningstar Category peer, the S&P 500, or other relevant bogies, such as the Russell 1000 Growth Index.

At the end of December 2019, the fund didn't hold some of the largest growth stocks in the benchmarks' and typical peer's portfolios, such as Amazon.com AMZN and Facebook FB. The fund invested about 24% of its assets in healthcare stocks, though, much more than the S&P 500 and Russell 1000 Growth indexes. The fund had more than the S&P 500 in technology stocks, nearly 29%, but that was less than the Russell 1000 Growth and included more off-the-beaten track tech companies like communications software firm, Broadridge Financial Solutions BR, a previous holding the fund rebought in 2019 when short-term concerns drove its share price down.

This is a conservative growth fund, but it's still a growth fund. Stock-picking drives sector allocations and it tends to find stocks that meet its strict criterion in growthy sectors like tech and healthcare. It will consider stocks from most sectors, though, including basic materials, where it owns industrial gas firm Linde LIN, which it sold in 2019 after its ROE dropped below 15%. While it is not an explicit environmental, social, and governance strategy, it is ESG-aware. It shuns fossil fuel stocks, for example.

People | Above Average A seasoned, disciplined investment team earns this strategy an above average People Pillar rating.

This team completed the transition from Jensen Investment Management's founding generation in 2018 without mishap. An experienced and capable team of investors remains, including Eric Schoenstein, chair of the investment committee, a comanager since 2004, and firm veteran since 2002.

Five other investors, none with less than 11 years of experience at Jensen and most still with a lot career runway ahead of them, compose the rest of the team. Rob McIver has been a comanager since 2005 and firm president since 2007. Kurt Havnaer joined the firm in 2005 as an analyst. Allen Bond and Kevin Walkush (a former Morningstar stock analyst) each joined as analysts in 2007. And Adam Calamar became an analyst in 2010 after working at the firm for two years in an operational role. Havnaer, Bond, Walkush, and Calamar became comanagers in 2015.

The team collaborates as generalists, but some members have gravitated to specialties. Havnaer takes the lead on consumer staples and industrials; Bond in healthcare; Calamar in consumer discretionary; and Walkush in technology and ESG research. The tenure and retention rates remain above average, and the managers invest in the fund. Schoenstein and McIver each invest more than $1 million here.

Parent | High Self-knowledge helps Jensen Investment Management earn a High Parent Pillar rating.

The investors who run this employee-owned firm know their circle of competence and don't stray from it. Since its 1988 founding, the firm has been a one-strategy boutique focused on historically profitable stocks with still-strong growth prospects and reasonable valuations. Though plans are in the works for a global version of its flagship Jensen Quality Growth strategy, the firm is not a product proliferator. The global fund will be its third launched since 1992. Like its other funds, the new fund will start with the same profitability requirements and rely on the same bottom-up due-diligence process.

Proactive succession planning, strong retention and tenure, close fundholder alignment, and a prevailing team-first attitude form the foundation of Jensen's culture. The firm has managed generational change well. Its founding investors have taken their leave since 2004, but Jensen, which requires all investment personnel to give at least a year's notice before retiring, found capable replacements well in advance. Its management team still has one of the highest five-year retention rates and average tenures in the industry. Each team member has money in the firm's strategies and most own shares of the advisor; investors run this firm like they invest--with discipline.

Performance This fund posts strong full-market cycle, risk-adjusted results.

A laser-like focus on firms with stable business models means this fund often shines in tough times, not rallies. Over a multiyear holding period, however, the fund has posted competitive absolute and risk-adjusted results versus the typical large-growth category peer, S&P 500, and Russell 1000 Growth Index. From the 2004 start of senior manager Eric Schoenstein's tenure through Jan. 31, 2020, the 9.2%-plus gain of the fund's cheapest I share class beat the category's 8.7%, edged the S&P 500’s 9.1%, and lagged the Russell 1000 Growth’s 10.3%, but did so with 90% or less of the volatility as measured by standard deviation of returns. The fund posted positive alpha for the time period and a higher Sortino ratio, a risk-adjusted return measure that factors in downside volatility.

The fund's upside has been its downside protection. Since Schoenstein began comanaging the fund in 2004, it has lost 80% as much as the S&P 500 and 75% as much as the Russell 1000 Growth Index when stocks have fallen. It's also lost less in downturns than the Morningstar Wide Moat Focus Index, a more small/mid-cap-leaning benchmark that also focuses on stocks with strong competitive advantages. This fund shed less than that index in 2018's rocky fourth quarter, for instance.

Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category's middle quintile. That's not great, but based on our assessment of the fund's People, Process and Parent pillars in the context of these fees, we think this share class will still be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Silver.