Jensen Investment Management’s market commentary for the third quarter 2014.
The Jensen Investment Philosophy
A consistent, sustainable investment process is vital to weathering all economic climates. The strength of our investment philosophy is based on an unwavering commitment to investing in quality businesses. We believe these quality companies possess sustainable competitive advantages, creating value as profitable businesses that can, over time, provide attractive returns with less risk than the overall market.
We are extremely selective.
From a pool of over 5,000 publicly-traded U.S. companies, fewer than 250 companies meet our initial threshold for inclusion in the Jensen Quality Universe. The first step in defining our investment universe is to identify all U.S. companies with a market capitalization of $1 billion or more. The Jensen Quality Universe then includes only those businesses that have produced a return on shareholder equity of 15% or greater in each of the past ten years, as determined by the Investment Team. We search for quality companies by targeting exceptional business performance combined with endurance. For those businesses that qualify, we have found the stamina of these quality businesses to be powerful; possessing sustainable competitive advantages and producing consistent earnings growth which, when compounded, can deliver tremendous value to shareholders.
Jensen: U.S. Performance Summary
The U.S. equity markets ended the third quarter with a muted positive return. The continuing trend of generally positive economic reports reinforced investor complacency and resulted in a mildly positive result for U.S. equity markets. Despite increasing global geopolitical tensions and the impending end to the latest round of Quantitative Easing, market volatility remained relatively low.
The Jensen Quality Growth Fund also produced a positive return; however it underperformed the S&P 500 Index. On a sector basis, the Fund’s stock selection in Consumer Discretionary and absence in Energy each contributed to performance. The Fund’s stock selection in Health Care and in Information Technology detracted from performance. On a company level, the top performer this quarter was The TJX Companies, Inc. (NYSE:TJX). TJX is the largest off-price retailer in the world with well-known concepts including T.J. Maxx, Marshalls, and HomeGoods. TJX stock was boosted in the quarter by a solid second quarter result that counterbalanced the negative sentiment that plagued the stock earlier in the year. The bottom performer this quarter was United Technologies Corporation (NYSE:UTX). The company is a diversified manufacturer of elevators, air conditioning units, jet engines, helicopters and a variety of aircraft parts. United Technologies’ stock performed poorly during the quarter due to short term investor concerns about the impact slowing emerging market growth might have on the company’s revenues and earnings. Despite these near term challenges, we are positive on the fundamental outlook for United Technologies as we believe long term growth in emerging markets will result in increased demand for many of the products manufactured by the company.
Jensen: Portfolio Changes
No outright purchases or sales of positions were made in the Fund during this quarter. Given the market rise over the past several quarters, valuations for the companies included in the Fund are closely monitored. The Investment Committee trimmed positions that had increased in value in order to take profits and deployed the proceeds to Fund stocks we believe were more attractively priced.
The companies held in the Jensen Quality Growth Fund reported incremental strength in their businesses during the most recently announced Q2 results. Most companies reported a steady increase in both top and bottom line growth, with several companies reporting an increase in market share. We believe these results support our conviction that portfolio companies continue to demonstrate the ability to grow consistently and have identifiable growth drivers that can sustain long term business value creation.
We believe that U.S. interest rates are likely to increase in the short-to-intermediate term as the U.S. Fed is expected to pivot from extraordinary accommodation to a slight tightening bias over the next twelve-to-eighteen months. Given this view and acknowledging the recent strong market performance, we believe investors may refocus their attention on business fundamentals. In such an environment, we are confident that strong businesses with competitive advantages, consistent free cash flow generation, and stable business models, such as those included in the Fund, can generate competitive returns. We continue to manage the portfolio with an unwavering focus on quality and growth with extra scrutiny on valuation given the recent run-up in stock market prices.