“When you leave this company behind, what will it look like?”
That’s the most important question Eric Schoenstein asks executives when performing his due dilligence. The co-portfolio manager of the Jensen Quality Growth Fund and principal with Jensen Investment Management knows he’ll get the standard answers to any questions he might ask. And as the saying goes, “it’s not about what they say, but rather what they do.” But it’s this is one question that seems to get to the core of what he’s looking for from the management teams at the companies he’s scouting.
“We have a quality growth strategy begun by Val Jensen in 1988,” he said Thursday at the 2012 Morningstar Investment Conference in Chicago. “Over the 24 years, the objective is really to mitigate both business risk and price risk.”
He said to mitigate business risk they look for companies with “a durable, sustainable competitive advantage with a high level of cash flow that delivers returns above the cost of capital.”
“In order to create value, we have to ensure the returns are above the cost of capital year after year,” Schoenstein added. “In this way, the returns compound over the long term, which leads to our long track record of success.”
As to mitigating the second factor, pricing risk, he simply said, “We make sure we don’t overpay.”
Sounds great in theory, but how does it translate to research and investing day-to-day?
The fund’s “boot camp” style discipline demands that the fund not consider a company if it has not achieved 15% return on equity for 10 consecutive years (you read that right; when they say quality, they mean quality). The small number of companies that meet this criteria means “it’s a limited universe in which to shop,” another reason for the fund’s relatively low turnover.
“We have a bottom-up due diligence process,” Schoenstein said. “It’s a long-term strategy that isn’t about next week, or even next year. Hence the original question; I want to know what their vision is for the company down the road.”
While the portfolio looks to be concentrated, the managers look at it as an advantage, as “they truly have their arms wrapped around each and every position,” thus lowering the risk. Companies in which it invests include PepsiCo, Procter & Gamble, Emerson Electric, Nike and Microsoft.
“Globally diversified companies are doing well,” he noted. “If they’re domestically domiciled, an emerging-market component is needed. Even if emerging markets are slowing over all, they’re still growing much faster than developed countries. For this reason, emerging markets should be 20% to 25% of the portfolio.”
The firm, which provides separately managed accounts in addition to mutual funds, is located in the decidedly non-financial hub of Lake Oswego, Ore., with total assets under management currently at $5.5 billion. The fund has an annualized 3-year return of 13.66% and a 5-year annualized return of 2%, according to Morningstar. Interestingly, the fund was down 28.97% in 2008, only to rebound with a 28.98% return in 2009, which made Schoenstein’s concluding comment all the more prescient.
“We look for consistency and predictability,” he said. “Only in this way can you smooth volatility and get needed returns with less risk.”