Wea Culpa

March 2, 2006

The Jensen Fund (JENSX) has been kicking around since August 1992. Unfortunately for investors, the fund has only beaten the Dow or the S&P500 in three calendar years since then. So far in 2006, Jensen is underperforming these indices, just as it did in the fund's first few months after its inception. 

Jensen has spent a lot of its existence underperforming the market – so why does the fund have a couple of billion dollars under management, and why does it garnish so many accolades in the press and in the analyst community?

Investors ignored Jensen through most of the fund’s life. Then a funny thing happened: the market crashed, and Jensen fund didn't. In 2000, 2001, and 2002, the fund whipped the broader market because its managers were not overweight in mega-cap tech and telecom stocks like everybody else. 

Jensen had big stakes in healthcare stocks, which met their strict, high-return-on-equity and valuation demands. Healthcare stocks killed the market in 2000, and value-oriented stocks did far better than the overall market during the downturn.

After the big wipeout of many hot funds, investors (as well as fund analysts and reporters) wanted a cure for the down market blues. They were looking for the anti-Janus. Jensen was the ticket.

Unfortunately, Jensen doesn't do so well when the market is rising. The fund is now among the very worst performers (literally the bottom few percent) of all stock funds since the beginning of 2003, a period during which the majority of stock funds beat the S&P500. The S&P500 is up about 50% over the last three years ending January 31st, 2006; the Jensen fund has gained just 28%. 

It is worth noting that Jensen still has a very good ten and five-year record. This is largely because not losing your shirt in a down market can be as important as not getting left behind in up markets – those three short years of market-beating returns give Jensen a big edge in long-term numbers. 

Still, these numbers disguise the fact that Jensen is a fund that does poorly when the market goes up. And, tech crashes aside, the market tends to go up. While we certainly don’t expect double-digit returns year after year anymore, we do expect stocks to deliver returns on average at least as high as the nominal GDP growth rate of the U.S., and likely, a few percentage points more.

The Jensen fund has been in our Moderate Powerfunds Portfolio subscription since April 2002. We track how our funds do against the broad stock market (S&P500) during the time period that we own them. Jensen has been our absolute worst performing stock fund by this measure. As noted two weeks ago in a trade alert, at the end of February we are selling our stake in this fund.

We fell for the Jensen fund because it met several of the Powerfund criteria. We like a low turnover ratio – Jensen delivers big time. We like a portfolio with a limited number of stocks – preferably under 50 if not 30 and with bigger bets on the top 10 (a concentrated portfolio), and Jensen delivers. We like low fees – Jensen delivers with a 0.85% expense ratio. We also like to be in out-of-favor categories – technically, Jensen is a large-cap growth fund (debatable) and this has been about the worst fund category over the last five years or so. And dumb money, performance-chasing investors usually avoid the funds in the worst performing categories like the plague. 

The big warning sign we ignored was the massive inflow of new money into the fund; a couple billion dollars of new money was invested in Jensen over a very short period of time. We rationalized our investment because the fund buys large-cap, very liquid stocks, which makes it more capable of managing huge infusions of cash. But very rarely do funds bring in this kind of money and go on to beat indexes. 

A similar problem hit Clipper (CFIMX) a few years back (another bear market darling that has since fallen on harder times). We recommended this fund as a large-cap value category favorite since September 2001, and dropped it from our favorites list in July 2003 because it was bringing in too much money. What happened since? Over the last three years ending January 31st 2006 Clipper is in the bottom 1% of larger-cap value funds. It has underperformed the S&P500 in 2003, 2004, 2005, and so far in 2006. Clipper still has over six billion dollars in assets, the money of investors who no doubt came in at the tail end of the market-beating numbers. 

In our February 2006 trades we cut back (from a 20% stake to 10%) on another now-popular fund (Fairholme - FAIRX) currently in our Growth portfolio. This fund has actually been beating the S&P500 by a wide margin (more than double at 25% as of January 31, 2006) since we added it to our portfolios in late 2004. While Fairholme looks to be beating the market again, making for the sixth out of the last seven years, we don’t like the popularity or the inflows (the fund has, at last count, over $1.5 billion in assets).

When we added Fairholme to our favorites list and first added it to our Growth portfolio in 2004, the fund had just over $200 million. While we are glad we bought a fund that was just named as the #1 Fund for risk-adjusted return in the preceding five years by a Barron’s/Value Line survey, we don’t like the inflows such an award creates. Moreover, Morningstar just added the fund to their analyst’s pick list for this fund category. About a third of the fund is in cash – the managers are not finding good places to put all the loot investors are stuffing into their coffers. 

You can’t avoid the occasional dogs when investing in mutual funds. Even the most powerful Powerfund might surprise us with mediocre performance. Still, if we followed some of our own research and indicators more strictly in this case, we would have passed on Jensen, or sold it earlier. We could certainly have done worse than Jensen (on fees alone the fund will do better than at least half the funds out there over the long haul), but we could also have done a lot better.