Jensen Quality Growth Fund letter to shareholders for the first quarter ended March 31, 2015.
H/T Dataroma
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.
Jensen Quality Growth Fund: 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 Quality Growth Fund: U.S. Performance Summary
The U.S. equity market, as measured by the S&P 500 Index, ended the first quarter with a slightly positive return. Investors’ struggle to balance incremental improvements in the U.S. economy and a strengthening U.S. Dollar with global growth concerns resulted in a muted quarterly return. The Jensen Quality Growth Fund also produced a positive return and outperformed the S&P 500 Index. On a sector basis, the Fund’s stock selection and overweight in Health Care and underweight in Financials contributed to performance. Stock selection in Consumer Discretionary and Consumer Staples detracted from performance.
On a company level, the top two performers this quarter were Equifax (EFX) and Ecolab (ECL). EFX outperformed during the quarter due to strong fourth quarter performance with organic sales growth estimated at 7% and double digit earnings and EPS growth. EFX raised its dividend by 16% and its sales and earnings guidance for the first quarter of 2015 exceeded street estimates. ECL’s stock price rebounded from a weak fourth quarter due to better-than-expected 2015 expectations for its energy-related business. We remain comfortable with our fundamental investment thesis for ECL based on the company’s end market diversity and highly consistent results.
The bottom two performers this quarter were Microsoft (MSFT) and United Parcel Service (UPS). Despite meeting quarterly expectations, MSFT’s stock decline was likely due to a tough comparison in its Windows business after delivering strong results a year ago. We believe the company’s fundamentals remain strong and are driven by the company’s Office franchise, its enterprise software business, and its strong cloud business. Despite PC weakness, we believe the PC market remains a large and meaningful market and MSFT’s position in that market delivers significant value to shareholders, especially in the enterprise market. UPS experienced higher than expected shipping costs in handling holiday season volumes and missed fourth quarter earnings as a result. Management is currently in the process of realigning the company’s infrastructure to better accommodate the higher holiday ecommerce shipment volumes.
Jensen Quality Growth Fund: Portfolio Changes
During the first quarter, The Jensen Investment Committee added a new name to the Jensen Quality Growth Fund, Johnson & Johnson (JNJ). JNJ is a globally diversified healthcare conglomerate with businesses in pharmaceuticals, medical devices and equipment, and consumer healthcare. We believe JNJ benefits from powerful competitive advantages across its businesses including size/scale, brand equity, intellectual property, and entrenched relationships with global healthcare organizations. In addition, we maintain a positive view of the company’s revenue diversity, exceptional balance sheet (JNJ remains one of only three companies in the world with AAA credit ratings), and relatively stable end markets. We expect JNJ to grow steadily due to increasing global healthcare demand, new product development, and acquisition activity. This view incorporates our expectation that growth will be partially tempered by patent exposures in the company’s pharmaceutical franchises.
The Fund exited a previously held JNJ position in January 2011. As we stated at the time, we did not sell JNJ because we believed it was a “bad company”. Rather, we liquidated the position to take a more targeted position in healthcare, and we believed the fundamental outlooks on Abbott Laboratories and Becton Dickinson were stronger at the time. Since that decision, JNJ’s fundamentals improved materially due to senior management stabilization, pharmaceutical pipeline successes, and supply chain improvements in the company’s consumer segment. Meanwhile, Becton Dickinson is now the top holding in the strategy and Abbott is no longer in the fund due to a capital structure related ROE decline. This new position was funded by targeted trims across select names held in the Fund.
The Jensen Outlook
We believe market volatility will continue as investors react to global economic developments and to the Fed’s comments regarding potential interest rate increases. During the fourth quarter of 2014, the rapid increase in the value of the U.S. dollar pressured company earnings. If the dollar remains strong, the earnings of U.S. companies with meaningful overseas revenues will most likely continue to be negatively impacted. In this environment, we believe it is important to invest in high quality companies with proven track records of operating successfully when currencies fluctuate significantly. In our opinion many of the companies in the Jensen Quality Growth Fund fit this profile. We continue our dedicated efforts to invest in high quality companies with the ability to deliver business returns (as measured by Return on Equity) in excess of their capital costs in a variety of market environments in order to deliver long term shareholder value.
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