Jensen Quality Growth Fund commentary for the third quarter ended September 30, 2015.
U.S. Performance Summary
The U.S. equity market, as measured by the S&P 500 Index, ended the third quarter with a negative return. The domestic economy continued to produce choppy but positive economic indicators. However, uncertainty surrounding U.S. monetary policy and emerging markets growth led U.S. stocks into negative territory. The Jensen Quality Growth Fund also produced a negative return, however it outperformed the S&P 500 Index. On a sector basis, relative outperformance this quarter was due to the Fund’s positive stock selection in Consumer Discretionary and in Health Care. The Fund’s overweight in Materials and stock selection in Industrials detracted from relative performance.
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At the company level, the top performer this quarter was TJX Companies (TJX). TJX’s reported earnings during the quarter delivered better than expected revenue and EPS results and confirmed top line strength across every category. Investors benefited from TJX’s strategy of lowered ticket prices that resulted in large volume gains. The largest detractor to performance was United Technologies (UTX). The company lowered its top and bottom line guidance for 2015 due to sluggish sales in its commercial aerospace aftermarket business and slowing growth in emerging markets, especially in China. We believe the market is focusing on short term emerging market weakness at UTX and other Industrials held in the Fund, and overlooking the strong fundamentals of these businesses and their long term growth opportunities in developing markets. We believe the growing middle classes globally and the evolution of developing economies represent compelling long term
Jensen Quality Growth Fund – Portfolio Changes
The Investment Committee made three wholesale name changes to the Portfolio during the quarter: Equifax (EFX) and Varian Medical Systems (VAR) were sold, and MasterCard (MA) was added.
Equifax (EFX), a long term holding in the Jensen Quality Growth Fund, was sold as the company’s stock reached Jensen’s estimate of full value. In our opinion, Equifax is a high quality business run by a capable management team. The company provides consumer and corporate credit information to potential lenders. While it is never easy to part ways with a strong company, we believe investors must be disciplined when it comes to the price paid for a business. All of the valuation metrics used in our process indicated that the company’s stock was fully priced when it was liquidated from the Fund.
The Investment Committee liquidated the Fund’s position in Varian Medical Systems (VAR) due to fundamental business concerns. Varian is a global developer and producer of radiation based medical and industrial equipment. When Jensen initiated its position in Varian in late 2011, high customer switching costs and the company’s technology leadership resulted in powerful competitive advantages. In our opinion, the fundamental investment thesis supporting the Fund’s position in Varian has deteriorated due to declining long-term growth and profit margin expectations in both the radiation oncology and x-ray products businesses. We attribute these declines to weakened end market demand and a negative shift in geographic mix.
The Investment Committee initiated a position in MasterCard (MA) during the quarter. MA is a global market leader in electronic payment processing in which it partners with merchants and banks to complete electronic transactions. Key to our investment thesis is MasterCard’s method of revenue monetization. The company generates revenue by earning a small percentage of the value of transactions using its cards, making top-line growth largely a function of global electronic purchasing volume. We believe the shift from cash-based to electronic-based payments is a powerful long term growth driver for the industry as cashbased payments still account for 85% of total global payments. The Investment Committee is pleased to add MasterCard to the Fund as we believe it is a high quality company capable of generating consistent and strong business value.
Questions around the timing of a potential increase in the U.S. Fed Funds rate and slowing emerging market growth have resulted in an increase in short-term market volatility. We take these near-term headwinds seriously but remain steadfastly focused on maintaining a long term investing philosophy.
At Jensen, our long term expectations are that U.S. interest rates will rise slowly and steadily. In periods of rising rates, we believe that our strong focus on valuation and underlying company fundamentals should allow us to add value by stock selection. Slowing growth in emerging economies has been a headwind to several Fund companies. Our focus in emerging market economies, however, is on companies that are able to take advantage of these turbulent times and make long term, strategic investments for growth, take market share, and preserve and grow pricing power.
We have long believed that over a full market cycle, our strategy can provide a measure of capital protection in down markets while providing capital appreciation in up markets. We believe the quality companies in the Fund maintain their ability to use internally generated cash to fund future growth initiatives while simultaneously increasing dividend payments and repurchasing shares. In our opinion, a focus on companies that deliver consistently high profitability while maintaining reasonable valuations is a prudent strategy in the current environment.