Investors tend to chase performance, flocking to stocks that have posted the best recent performance. But that strategy can easily backfire.

Hot shares typically cool, causing panic. So “buy low and sell high” gets turned upside down.

How can one avoid this pattern? One way is to put together a portfolio of quality companies and stick with them — for years.

Last month we reviewed the Jensen Quality Growth Fund, a U.S. mutual fund that has a remarkable performance track record combined with very low turnover. Eric Schoenstein, one of seven co-managers of the fund, explained the team’s stock-picking philosophy and consistent outperformance. We’ve now taken a closer look at the fund with Allen Bond, another co-manager, who discussed stocks the fund has bought and sold over the past year.



The Jensen Quality Growth Fund JENSX, +0.79% is run by Jensen Investment Management, based in Lake Oswego, Ore. It is a concentrated, large-cap stock fund. We’ll list all the fund’s holdings in a moment, but first, here’s a look at how its performance has stacked up against the S&P 500 SPX, +1.05% this year and its average annual performance against the benchmark index for several periods:

Total return - 2016 through Sept. 16 Average annual return - 3 years Average annual return - 5 years Average annual return - 10 years Average annual return - 15 years Jensen Quality Growth Fund Class J 9.1% 10.9% 13.9% 7.9% 6.9% S&P 500 6.3% 10.3% 14.4% 7.2% 6.7% Source: FactSet

So the fund has outperformed for all periods except for five years, for which its average return has been slightly behind the index. This is no easy feat, considering the high share of funds that lag behind the index for all periods.

Bond, in an interview, said the fairest way to compare performance against the index is to “measure investment returns over a full market cycle,” from peak to peak. Before the most recent recession, the previous closing high for the S&P 500 was Oct. 9, 2007, and the index hit its most recent record Aug. 15, 2016:

FactSet

So for the current stock-market cycle, as defined by Bond, the fund has outperformed.

Fund-analysis firm Morningstar ranks the fund in the first percentile for one year among 1,600 large-growth funds. For three years, the Jensen Quality Growth Fund’s Class J shares rank in the 18th percentile, slipping to 24th for five years and 39th for 10 years. Morningstar rates the fund’s risk as “low” within its category, and says the average annual turnover of its portfolio is 14%, which compares with 63% for the large-growth category.

The entire portfolio

The fund currently holds shares of 27 companies, which compares with an average of 98 for funds in Morningstar’s large-growth category. Schoenstein shared the management team’s investment criteria with us in August. The main screen that the managers use when beginning their analysis and decision process is to include only companies that have achieved returns on equity of at least 15% for 10 straight years. The fund managers then decide whether they’re satisfied with the way the companies deploy the cash they generate, and if they’re likely to remain competitive.

Here are all the stocks held by the $5.4 billion fund:

The remaining 3.98% of the fund was cash. For two of the stocks, the return on equity (ROE) figures were below Jensen’s 15% minimum requirement, but the fund managers use adjusted earnings figures, which can push up ROE.

Pepsi or Coke?

The fund’s largest holding as of Sept. 6 was PepsiCo Inc. PEP, +0.69% , and the smallest was Coca-Cola Inc. KO, +1.16% . One obvious difference between the two cola makers is that Pepsi’s return on equity has averaged 31% over the past five full years, compared with 26% for Coke.

Bond said the most important difference between the two soda giants is that Pepsi has “a competitively dominant snack business.” Pepsi’s Frito-Lay North America business accounted for 23% of total revenue for the quarter ended June 11, and the snack unit’s sales were up 3%, while Pepsi’s total revenue was down 3%.

Bond said the valuation of Pepsi’s stock remains “pretty attractive,” despite a 16% return over the past 12 months. The company’s diversification, high ROE and cash flow suggest Pepsi is a low-risk stock, he said.

Coke is another “extremely low-risk stock,” Bond said, because of its low price volatility. But consumers are losing their taste for carbonated soft drinks, which make up “roughly 70%” of Coke’s sales.

Bond said the Jensen team likes both Pepsi and Coke because they are looking for “steady, predictable products.”

Recent sales and purchases

Bond said the Jensen team focuses on three main areas when deciding to sell a stock:

They want ROE of at least 15% on a consistent basis.

They will sell if the stock no longer trades at a discount to their estimated full value for the company.

If they see “a better idea” in a company’s industry, they will make a change.

Over the past year, the fund sold its entire positions in three companies:

Colgate-Palmolive Co. CL, +1.17% “was a pure valuation sale,” Bond said. “We think Colgate is a valuable business, with incredible market share, especially outside the U.S. We saw it exceed our estimated full value so we sold that stock in March.”

“was a pure valuation sale,” Bond said. “We think Colgate is a valuable business, with incredible market share, especially outside the U.S. We saw it exceed our estimated full value so we sold that stock in March.” After DuPont DD, -0.74% announced the retirement of CEO Ellen Kullman in October 2015, Bond and his colleagues decided to sell the stock because interim CEO Edward Breen “had a plan to break up the company and merge.” DuPont announced a deal with Dow Chemical in December. “We were getting concerned about fundamental uncertainty, but the stock rose so high, it was near our valuation estimate,” and was therefore sold in December, he said.

announced the retirement of CEO Ellen Kullman in October 2015, Bond and his colleagues decided to sell the stock because interim CEO Edward Breen “had a plan to break up the company and merge.” DuPont announced a deal with Dow Chemical in December. “We were getting concerned about fundamental uncertainty, but the stock rose so high, it was near our valuation estimate,” and was therefore sold in December, he said. Bond said the fund sold its shares of Medtronic PLC MDT, -0.42% , which it had held for nearly 20 years, in November. The company’s acquisition of Covidien PLC, which was based in Ireland, was a tax-inversion deal, designed to avoid U.S. income taxes. This resulted in “a big markup in the equity on the balance sheet,” Bond said, which meant the ROE had fallen below a level Jensen would be comfortable with.