August 25, 2003

Robert Millen of the Jensen Fund

S&P Rank: 3 Stars

Aug. 18, 2003

Steady and Rising

Quick Take: It's not what it owns, but what it doesn't own that has weighed on the Jensen Portfolio (JENSX) this year, says Robert Millen, one of the fund's five portfolio managers. The $1.6 billion fund has very little exposure to information technology stocks, he says, which investors have been bidding up in recent months. The managers tend not to put a lot of money into these companies because most of them are young and haven't yet put up the kind of numbers they want to see.

The Jensen fund focuses on companies that increase revenues and earnings year-in and year-out. The fund's managers won't even consider investing in a company unless it has generated returns on equity of at least 15% in each of the past ten years. That alone excludes a lot of tech firms.

The lukewarm performance of the portfolio's health care stocks, its heaviest sector weight, has also worked against it since the end of last year, Millen says. This year through July, the Jensen fund gained 5%, versus 15.7% for the average large-cap growth fund. Over the long term, however, the portfolio has handily topped its peers while displaying a lot less volatility, giving investors a much smoother ride. For the ten years ended last month, the Jensen fund rose an average annualized 11.8%, versus 7.7% for its peers.

The Full Interview:

Of the thousands of companies that start the race to make it into the Jensen fund only a small fraction clear the first hurdle, and just a handful of those finish.

Robert Millen and the other four stock pickers who manage the portfolio begin by considering 10,000 or so companies, seeking those that have generated returns on equity of at least 15% in each of the last 10 years. That filters out all butabout 110 candidates.

Then the team looks for companies that have grown consistently and tries to forecast long term prospects for them and their industries. On average, the companies the fund owns increase their sales by 6% to more than 20% annually, while their bottom lines rise by 9% to 20%, Millen says.

"We're looking for companies that have demonstrated sustainable competitive advantages, and that have the ability to earn at a level higher than their peers," Millen says.

Free cash flow is a key part of the team's focus when it comes to buying stocks. They want companies that generate an excess, so that management has the luxury of determining how to invest the overflow by, among other things, making acquisitions, repurchasing stock or paying dividends, Millen explains. Low debt is another preferred characteristic.

The managers also keep an eye out for cheap stocks. They will purchase only shares selling at a discount of at least 40% to the intrinsic value the team calculates for a business, Millen says.

The fund can own companies of any size, but its strict requirements have the effect of limiting it to large-cap stocks, Millen says.

After potential investments have passed through all of the fund's screens, only some 25 enter the portfolio. That number provides adequate diversity, while facilitating research and enabling winners to significantly boost returns, Millen says.

"If you pick the right companies and you have fewer of them, then each has the potential to have greater impact on your performance," Millen says. But, he adds, "that can work both ways. It can be up or down, and we've had cases where it's been down."

The short list of stocks the managers choose from doesn't change much from year to year, according to Millen. The fund's composition, too, seldom changes, he says. The portfolio's turnover rate over the years has averaged less than 15%, he says.

Two relatively new additions are consumer products giant Colgate-Palmolive (CL), which the fund bought last September, and drug maker Johnson & Johnson (JNJ), a May, 2002, investment. Millen says he and his colleagues had wanted to own both for a long time, but until the market's decline last year their stocks had been too expensive.

Colgate-Palmolive stands out because of its well-known brands, such as Ajax cleansers and Science Diet pet foods, Millen says.

Millen says he likes Johnson & Johnson, which he calls "one of the best managed companies in the world," because its historical and projected growth rates are in the mid-teens.

Stocks of health care companies like Johnson & Johnson accounted for about 29% of the fund's holdings at the end of the second quarter, Millen says. It's No. 1 holding at that time was Stryker Corp (SYK), a manufacturer of surgical equipment and medical products, including orthopedic implants.

"It's almost a recession-proof business," Millen says of Stryker, whose profits he expects to increase by 20% or more for the next ten years.

The fund's second largest holding on June 30 was pharmaceuticals manufacturer Pfizer, Inc (PFE).

Millen notes that as a result of the company's purchase of Pharmacia in April it has ten of the 30 best selling drugs in the U.S., including its Lipitor cholesterol lowering medication. He envisions Pfizer generating earnings growth in the mid-teens in the next decade.

The fund's other investments in the sector included drug companies Abbott Laboratories (ABT) and Merck & Co (MRK), and medical device maker Medtronic, Inc (MDT).

The performance of its health care stocks has been mixed this year, Millen says. Stryker has risen 20%, but the drug makers have not done well, he says. The lackluster results of this portion of the portfolio was one reason why the fund has trailed its peers this year, Millen notes.

The portfolio's limited exposure to information technology stocks, which have been boosting the market lately, has also hurt the fund, the portfolio manager says.

The fund typically does not invest heavily in these kind of companies, Millen says, because for the most part they are too young to have the financial track records it focuses on. Many have not moved into the black yet, he says.

The fund does own two stocks that Millen notes can be classified as information technology holdings: Automatic Data Proc (ADP) and Paychex Inc (PAYX), which use computers to process payrolls and data for companies.

"It's not so much that we have companies that aren't performing, because we do," Millen says of the fund's returns this year. "It's more that we're just not in some of those companies that have been driving the indexes this year."

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