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Riding Trend Drivers and Enablers
Plumb Balanced Fund
Interview with: Thomas Plumb

Author: Ticker Magazine
Last Update: May 07, 11:57 AM EDT
Unlike other balanced funds, which rely on conservative equity exposure and bond income, the Plumb Balanced Fund invests in growth stocks and uses fixed income to moderate stock market volatility. Founder and portfolio manager Thomas Plumb focuses on identifying big secular trends and companies that enable or benefit from these trends, as such businesses have the potential to grow in any environment as long as they are fundamentally sound.


ďWe rely on growth stocks to generate our incremental return and we focus on companies with unlimited upside. Our approach is identifying a big trend and then looking at who will benefit from it and enable it.Ē
Q: What is the history of the fund?

A: I started a balanced mutual fund called Thompson Plumb Balanced Fund in 1987, because there was interest from individual investors, who wanted to participate in the strategy of our regional institutional accounts. I was affiliated with that fund for 20 years and eventually sold it to Dreyfus Corporation. It is still in operation under the name Dreyfus Balanced Opportunity.

When my relationship with Dreyfus ended in 2007, we started the Plumb Balanced Fund. So the fund has more than 10 years of history but the strategy is older.

Q: What is your investment philosophy? How does it differentiate you from other balanced funds?

A: Balanced funds tend to have conservative equity performance and they attempt to generate income through their fixed income portion, while we have a different perspective.

We all know that historically stocks tend to have higher returns than bonds but are more volatile. Stocks and bonds are not only uncorrelated, but in adverse situations are typically negatively correlated. So a portfolio that uses stocks and bonds should be geared to using the benefits of the underlying assets to accomplish its long-term investment goals. As you increase the stock exposure, you capture more of the incremental return of an all stock portfolio without capturing all the incremental risk until you get to about 60% or 70% in stocks. To capture the next 1% incremental return that the stock market offers over time, you have to increase your volatility or risk by over 2%.

We have found that the sweet spot for asset allocation is anywhere from 50% to 75% in stocks and thatís how weíve built our portfolio. The fixed income investments primarily moderate the volatility of the stock market. We tend to take a little credit risk by owning corporate bonds, but we avoid interest rate risk, because in my 40 years in the industry, I still havenít seen anyone to be really good at predicting interest rates.

Q: What type of stocks do you invest in?

A: We rely on growth stocks to generate our incremental return and we focus on companies with unlimited upside. We tend not to buy value stocks or stocks for which we expect reversion to the mean. Instead, we look for companies that are able to grow in a variety of economic environments, because they are breakthrough type of companies.

The world may only show 2Ė3% real growth over time, but that growth is a composite of many divergent trends. Some segments of the economy can grow much faster than that for a very long time. Our approach is identifying a big trend and then looking at who will benefit from it and who is enabling it. Right now we own many companies in the financial service and technology industries, because we believe that we are still in a secular growth phase.

For example, we focus on financial services because people increasingly make purchases through mobile and digital devices and are moving away from cash and checks. That trend is going to continue, regardless of how fast the economy is growing. Internet or digital purchasing in the U.S. is growing three to four times faster than nominal purchases in traditional stores.

Q: What are the key elements of your research process?

A: We have a top-down process, but it is quite different from the process of other mutual funds. We donít try to predict whether the U.S. GDP will grow by 3.5% or 3.2% in the fourth quarter because that has limited value for us.

Instead, we research trends and changes. Then we identify the players in the specific industry, and then we start a due diligence process. We analyze the financials of these players, how they use their capital, how the management is rewarded and what is its ability to execute.

The next step is quantitative analysis, where we examine the recurring revenue streams and the cash flow generation of the business model. We look for growth, so we aim to find companies with accelerating top line and with the ability to increase margins. Recurring revenue streams are significant for the ability to predictably increase margins.

Overall, we believe that the companies, which will be leaders over five or ten years, first have to be able to execute a business plan that rewards themselves and the shareholders. So, the key elements are increasing revenues and predictability by recurring revenues.

Q: Could you give us some examples of specific holdings that illustrate your process?

A: Currently our largest holding is Visa, Inc, which is an enabler of the digital transaction structure. If thereís a physical transaction, about 14 cents on every dollar is processed through a Visa card, while in online transactions whether through Amazon or Wal-Mart, about 42 cents on each dollar uses a Visa card.

Thatís an example of a company thatís participating with high penetration in the fastest growing segment of retail. The revenue stream is recurring, because people continue to use it in daily transactions. Even people from the older generation, who used mostly cash or small checks, are now doing their purchases through cards. We can see how Visa enables the transformation and benefits from it because it provides the service to make it happen.

While we own some traditional consumer product companies, we focus on companies that allow the consumer to make purchases regardless of the outlet. We are not betting that Costco Wholesale Corp will beat retailer T.J.Maxx, for example. We are just betting that whoever goes into those stores or buys online from them, will probably use Visa or Mastercard. Thatís why Mastercard Inc is also one of our largest holdings. Until we see the pattern maturing, or a significant new entry, or a new process that will change the market shares, these companies will continue to be our largest holdings.

We also own chip companies that enable that transformation and provide the technology backbone for financial institutions. Finally, there are companies that deal with the consumer and actually make the transactions, such as Amazon, Alibaba, or Tencent. Black Friday and Cyber Monday generated $5 billion sales all over America. Alibaba, which created its own holiday called Singlesí Day, generated over $25 billion on November 11th and 80% of those transactions were done through mobile devices. From our perspective, these are all parts of the chain.

The idea is that we donít want to spend our time thinking whether 15.8 or 16.5 million cars will be sold in the U.S., because when we own the right technology companies, we know that every car sold will use more smart microcontrollers for safety and comfort devices. It is a question of penetration and often small products can develop significant recurring revenues.

Our equity strategy is to make sure that the companies in the portfolio have the ability to monetize that growth and are well positioned with the trend. It is not a secret that Amazon is growing five times faster than Wal-Mart, so we are watching the story, the execution, and we continue to hold them.

Q: Why is Visa considered indispensable in financial transactions?

A: Apple is probably the most profitable company in the world, but it is valued at 16 times earnings. That means that the market views Apple as a product cycle company and doesnít give it the full benefit of its market dominance. When adjusted for cash, Apple would trade at a 25% discount to the market multiple. I believe thatís because it hasnít structured a recurring revenue stream. Even Microsoft has converted to a subscription model and has developed a recurring revenue stream. Its multiple is 60% higher than that of Apple.

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Sources: Data collected by 123jump.com and Ticker.com from company press releases, filings and corporate websites. Market data: BATS Exchange. Inc