Starting Lineup

The Jensen Fund isn’t exactly a household word. But then again, not long ago, “Amazon” just referred to a river basin in Brazil. The large-cap growth fund has gained notoriety by performing well when its category peers don’t. For example, in 2001, with the S&P 500 and Russell Top 200 Growth down 11.91% and 20.53%, respectively, Jensen Fund held flat, at 0.03%. As for its relative performance within the Morningstar large growth category, the fund ranked in the top 2% for 2001, and in the top 6% for the five-year period ending December 31, 2001. Not bad for a fund not many have heard of, which on February 8, 2002 had net assets of $151 million and expenses below one percentage point.

The fund’s genesis seems directly tied to its success. Jensen Fund sprang forth from Jensen Investment Management, an RIA in Portland, Oregon. While the fund was authorized in 1992 as a public mutual fund, before then (and for some time afterward) it was put to work almost exclusively for the firm’s clients in the Pacific Northwest, where the fund was registered in just five states. An impressive long-term track record and some inquiring phone calls prompted Jensen’s directors in the first half of 2001 to “make some effort to let the world know what we’re doing,” as Jensen’s Gary Hibler puts it. The fund was registered in all 50 states, and joined Schwab’s and Fidelity’s platforms. Word began to get out.

Jensen Investment Management has five principals who also serve as Jensen Fund managers. Most have worked together since the fund went national in 1992. Their investment and business backgrounds play key roles in their ability to analyze prospective companies, which they do by viewing companies not just as common stocks but as performing organizations. The principals are Val Jensen, chairman, Gary Hibler, president, Robert Zagunis, Robert Millen, and David Davies.

“We’ve all been concerned with payrolls, we’ve all had the experience of running a business,” says Jensen, “and I think that helps us when we look at companies.” It helps, too, that Jensen Fund managers are investors in their own endeavor.

The number of holdings in the Jensen Fund is limited by intent, as opposed to being the byproduct of any screening process, though as Jensen notes, “owning the best companies is a limiting factor.” At present, Jensen Fund holdings total 26, though the number generally ranges between 20 and 25. The modest group enables Jensen fund managers to acquire a profound intimacy with each holding.

We spoke recently to three of the fund’s managers–Jensen, Zagunis, and Hibler–to unearth their shared beliefs and the methodologies they employ.

When you go back a few years–2000 comes to mind–it seems that when your fund category was doing well, you were trailing a bit, and when the fund category was performing poorly, you did extraordinarily well. Why? Hibler: We knew why we were trailing; the market was frothy out there and it was overvaluing the companies that were leading the S&P. If you go look at those companies today, they are all trading at 50% of where they were back at that time. Our strategy is to try to understand what a business is worth, and never pay more than what a business is worth to acquire it. At that time, the companies that were leading the S&P were the Intels, the Microsofts, the Suns, and the Ciscos of the world. Their valuations weren’t even close to being supported by their cash flows.

Zagunis: When you analyze the performance of the S&P, you know there’s 500 companies in there, but the driving force of that S&P was not 400 of those companies, it was a very small minority. The upshot–from our point of view–is that the underlying shareholder value creation was not real. Our focus is based on the business performance and persistency of operations and pre-cash flows in creating shareholder value. That doesn’t go away when you wake up in the morning.

Jensen: I’d like to put it even a third way if I could. We think a company has to earn its increase in price. In other words, there’s a definite relationship between a company’s earnings and its price. The market continually over- and undervalues those earnings, but if you take a company earning $1.50 and paying a 50-cent dividend, then in a very simplistic way, the price of the stock should go up $1.00, because that’s the value that was added. We’re really back to that business value. We just looked at a company that we don’t own in any amount, BristolMyersSquibb, and over 35 years it increased earnings at an average rate of 12.5% a year. Do you know what the market did to its price over 35 years? It went up an average of 12.5% a year. If you look at the statistics, this happens over and over and over again: The long-term business performance relates to the long-term stock performance.

You’re not too heavy into technology, and you don’t own energy or retail. A lot of your category peers with those holdings aren’t doing well at the moment. Do you avoid those holdings as a rule? Hibler: We didn’t set out to say we don’t want to own any techs or any retail. We only wanted to own the best businesses out there. Our definition of a good business starts with having to have a 10-year record of absolutely pristine business performance. So that eliminates all cyclicals, eliminates a lot of the techs. That’s what starts to drive our selection process.