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Noteworthy Strategies: Principal Blue Chip Fund

The approach behind Principal MidCap and Principal Blue Chip fund

Laura Lallos


In every Morningstar magazine issue, Undiscovered Manager profiles a noteworthy strategy that hasn’t yet been rated by Morningstar Research Services’ manager research group.

Tucked within Principal Global Investors, which runs more than $450 billion of assets as part of Fortune 500 company Principal, is equity boutique Aligned Investors. There, chief investment officer Bill Nolin and director of research Tom Rozycki oversee a $22 billion portion.

Most of that is in a successful mid-cap strategy Nolin has run since 1999, which is closed to new investors. The mutual fund version, Principal MidCap PCBIX, earns a Morningstar Analyst Rating of Silver. However, the lesser-known Principal Blue Chip PBCKX applies the process to larger-cap names and has been open to newcomers since it launched in 2012. Both strategies follow a long-term, bottom-up, fundamental approach that distinguishes them from Principal-branded equity strategies, which have a more quantitative spin.

To signal that distinction, the team adopted the Aligned Investors name when it was officially carved out as an autonomous boutique within Principal in 2015. The name alludes to Nolin and Rozycki’s preference for investing in companies run by owner-operators or demonstrating an owner-operator culture—where management’s personal interests are aligned with those of company shareholders, a deep knowledge of the business fosters innovation, and a long-term perspective predominates.

“We contrast managers who have real skin in the game with ‘cash-paid’ CEOs,” Nolin says. “Someone with their family’s net worth in the company, who thinks about risk and acquisitions differently. They aren’t going to buy back stock like Citigroup C did in 2007 and then issue tons more in 2009, or make acquisitions at the top of the cycle.”

A closer look at the process

The owner-operator angle is one of four cornerstones underpinning the process. In addition, the team seeks high-quality businesses with sustainable competitive advantages; it evaluates buyers, suppliers, and competitors to determine whether a company enjoys barriers to entry such as economies of scale, switching costs, and distribution advantages. The team then employs a valuation discipline to build in a margin of safety before buying, forecasting financials and running discounted cash flow models.

These three cornerstones help keep risk in check by fostering careful buy decisions. The fourth cornerstone is risk reduction. After purchase, the team monitors holdings for adverse developments that might signify fundamental change. Early warning signals include disruptive technologies, regulatory changes, and eroding barriers to entry.

As the funds’ relatively low turnover suggests, the process has identified picks worth holding for the long term. Both funds have turnover ratios well below the median for active funds in their respective Morningstar Category, mid-cap growth for the MidCap fund and large growth for Blue Chip fund.

“Of the 40 companies in the Blue Chip fund portfolio,” Nolin says, “18 were in there on Day One.”

Similarly, nearly half of the names in MidCap’s portfolio at the end of May were first purchased more than five years ago, according to Morningstar’s data.

The Blue Chip fund portfolio

The MidCap fund starts by screening the smallest 800 companies in the Russell 1000 for those with high returns on investment capital and healthy profit margins, and the Blue Chip fund expands the process to the largest 200 stocks. The buy-and-hold philosophy allows some companies to remain in the MidCap portfolio after they grow into large-cap territory, though at least 80% of assets must be within the Russell Midcap's market-cap range. (As of May 31, MidCap held nearly 60% of assets in large-cap stocks by Morningstar's measure, compared with less than 35% for its average peer.)

The two funds had 23 holdings in common at the end of May, representing about 55% of the MidCap fund and 33% of Blue Chip fund. MidCap’s largest holding at nearly 5% was Brookfield Asset Management BAM.A, which it has held since 2005. The company has a similar weight in the Blue Chip fund portfolio and is among the top 10 names.

According to Nolin, the Blue Chip fund portfolio breaks down roughly as one third names that are among the large-cap holdings in MidCap; one third “graduates” of the MidCap fund, such as Costco COST and American Tower AMT; and one third “great companies like Berkshire Hathaway BRK.B that we were never able to own in MidCap.”

The Blue Chip fund is not under Morningstar analyst coverage, so it does not have an Analyst Rating. The fund recently made the Morningstar Prospects list, a collection of lesser-known or newer strategies that Morningstar’s manager research analysts deem promising for full coverage in the future.

This blog post is adapted from an article that originally appeared in the August/September 2018 issue of Morningstar magazine. Read the full article or subscribe to the magazine for free. 

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