Jensen Quality Growth Fund commentary for the first quarter ended March 31, 2016.
H/T Dataroma
U.S. Performance Summary
With a return of 1.35%, the U.S. equity market, as measured by the S&P 500 Index, increased modestly during the quarter. This quarter combined two strikingly different performance patterns. The first half started with volatile and negative returns during which investors sought the stock of high quality companies1. The second half of the quarter reversed earlier losses with a strong rebound as investors reacted to more positive economic news.
The Jensen Quality Growth Fund successfully navigated this volatile quarter and outperformed the S&P 500 by more than 450 basis points. On a sector basis, positive stock selection in Health Care and an underweight position in Financials boosted relative performance. The Fund’s lack of exposure in Utilities and Telecomm Services detracted from relative performance.
At the company level, the top performer this quarter was 3M (MMM). The company’s fundamentals remain intact, and we are pleased how 3M is navigating global volatility. The company is one of the five largest holdings in the Fund, and it participated in the updraft realized by the Industrial sector during the quarter. The largest detractor to performance was Ecolab (ECL). Ecolab’s exposure to the energy end market prompted the company to issue guidance for 2016 slightly below consensus expectations. Jensen’s investment thesis remains sound as we believe the company’s competitive advantages, including its sale and service infrastructure and a business model characterized by recurring revenue, allow Ecolab to grow global market share and deliver relatively stable business results.
Jensen Quality Growth Fund – Portfolio Changes
The Jensen Investment Committee enacted two Fund changes during the quarter – the purchase of Apple, Inc. (AAPL) and the sale of Colgate Palmolive Co (CL).
Over the years, we’ve answered the question many times as to why we didn’t own Apple. Quite simply, it didn’t meet our requirement of 10 consecutive years of greater than 15% return on equity. In 2015 the company qualified, and after extensive research, we added it to our bench of potential investments as we believe it possesses the qualities we seek in a quality growth company. Fundamentally, we believe the company’s competitive advantages that comprise its iconic brand, innovation, and economies of scale are significant. Additionally, we believe Apple enjoys a strong network effect from the apps and services businesses that, in our opinion, continue to strengthen as the company expands services such as Apple Pay and Apple Music. While the company has generated high double digit top line and bottom line results in the past, we believe that rate of growth will slow but mature into an attractive growth profile. We believe now is the time to add Apple to the Fund because of its attractive valuation and strong fundamentals. We see the enterprise evolving from primarily a premium consumer electronics company to one that offers a robust ecosystem of apps and services that serve to enhance customer monetization over the life of the relationship and increase customer switching costs from the Apple ecosystem. While this business represents just under 10% of Apple’s revenue, we believe its high margins can enable Apple to preserve and even enhance the company’s overall profitability even if lofty device margins become pressured in the future.
Colgate, a long-term holding in the Jensen Quality Growth Fund, was sold during the quarter. The rich valuation on the company’s stock prompted the sale. In our view, Colgate is a high quality company with strong brand names and dominant market positions in many of its product categories. The company produces and sells a variety of oral care, personal care, home care and pet related products. Over the years, the company successfully reduced costs and invested a meaningful portion of the savings in innovation and brand building, leading to solid organic sales growth rates. Selling fundamentally strong companies such as Colgate is never easy, but we believe investors must remain disciplined when it comes to the price paid for a business. At Jensen, we strive to own shares in high quality enterprises, but only if those shares are attractively priced. Colgate’s stock outperformed the market by a wide margin over the past ten years, and all of the valuation metrics used in our process indicated that its stock was fully priced at the time of liquidation.
The Jensen Outlook
Although the quarter began with a risk-off reaction to volatility in oil prices, concerns about Chinese growth and increasing U.S. interest rates, all of which rewarded high quality stocks, market sentiment later whipsawed into a “relief rally” that lifted the entire market. While it’s possible the market’s recent rally continues, uncertainty remains regarding the direction of interest rates, global GDP growth and corporate earnings, which may result in a return to volatility. In such an environment investors typically value company fundamentals and stock price valuations that favor high quality companies instead of seeking broad risk exposures. We believe Jensen’s consistent focus on the long-term ownership of companies with sustainable competitive advantages, resilient financial results, and attractive long-term growth opportunities will result in shareholder value.
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.
