When it comes to movies, sequels are only occasionally as good as the original (think The Godfather: Part II, which many critics consider to be as superb as, if not better than, the original The Godfather). More often than not, however, follow-ups stink (think The Sting II and Caddyshack II).
Sequels are noteworthy in the mutual fund business, too, especially when a company with a good record decides after operating a single fund for many years to release a second product. Such is the case with Jensen Investment Management, a Portland, Ore., firm that for more than 18 years has offered one -- and only one -- fund. That fund, Jensen Portfolio (symbol JENSX), has had a respectable long-term run. Over the past 15 years through October 25, Jensen returned 8.4% annualized, compared with 6.8% for Standard & Poor’s 500-stock index.
Because Jensen Portfolio focuses on companies that deliver above-average growth, our interest was piqued when we saw that the firm’s second fund, unveiled last March, would be called Jensen Value (JNVSX).
The same eight-man team runs both funds, which adhere to an unusually rigid approach to stock selection. To qualify for inclusion, a company must have a stock-market value of at least $1 billion (a modest requirement) and must have generated a return on equity, a measure of profitability, of at least 15% for each of the past ten years. That is a steep hill to climb and, in fact, only 140 companies or so currently pass muster.
Not surprisingly, given its name, Value differs from its older sibling by paying more heed to price. After seeing which companies make the cut for size and ROE, the managers apply a series of factors that relate key business measures to share price. Co-manager Eric Schoenstein won’t divulge many details, but he says he and his colleagues look at such things as sales turnover (how quickly a company sells its product); free cash flow (the cash profit left after deducting capital outlays needed to maintain the business); and the ratio of a company’s enterprise value (stock-market capitalization plus debt outstanding, minus cash on the balance sheet) to operating income (earnings from operations and excluding the impact of one-time events, such as charges and asset sales).
The managers then rank the stocks according to their value criteria and consider those in the top third eligible for the Value fund. Lastly, they impose limits on each stock and each sector within the portfolio. That is, any one stock can account for no less than 0.5% and no greater than 2.5% of the fund’s assets. And the holdings in a particular sector may not equal more than twice the weighting of the sector in the Russell 3000 index, the fund’s benchmark.
So far, the fund’s process has resulted in heavy doses of health-care and business-services companies. As of September 30, the 52-stock portfolio’s biggest holdings were Lexmark (LXK), a maker of PC printers; drug producer Pfizer (PFE), health insurers UnitedHealth Group (UNH) and Cigna (CI), and Waddell & Reed Financial (WDR), which manages mutual funds.
But those companies may not stay in the portfolio for long. The Value fund reranks and rebalances its holdings every quarter. If a stock appreciates too much, for example, it may fall out of the top third of the rankings, requiring its expulsion from Jensen Value. As a result, the fund expects a turnover rate of about 100% per year, meaning that the typical stock will be held for one year, on average. By contrast, the turnover ratio at Jensen Portfolio is typically about 12%, implying an average holding period of more than eight years for each stock.
The initial minimum investment for Jensen Value is $2,500. The fund, which currently holds just $11 million in assets (compared with $3.1 billion in Jensen Portfolio), levies no sales charges and is currently capping its expense ratio at 1.25% per year.
Despite Value’s solid pedigree, we don’t think you should rush to invest. Although the Jensen team tried out their new investing strategy for two years with an in-house account before launching the fund, it is new enough to suggest taking a wait-and-see approach until the fund racks up a longer record. That the managers are keeping so much of their strategy under wraps is another reason for caution.
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