Sustainable Growth through Quality
Polen Growth Fund
Author: Ticker Magazine
Last Update: Oct 05, 3:06 PM EDT
|Although the market can sometimes be out of sync with fundamentals, it is the underlying earnings growth that drives performance in the long run. Based on this philosophy, Polen Growth Fund invests in its best growth and quality ideas with an investment horizon of at least five years.
ďWe donít try to generate returns through repeating the process of buying low and selling high. Instead, we identify the 20 business that we believe are the best, pay a fair price for them, own them over time and let the underlying earnings growth drive the returns.Ē
Q: What is the mission and history of the fund?
Our stated mission is to: ďPreserve and grow client assets to protect their present and enable their future.Ē
We donít think about it as simply managing money for a pension plan or for nameless accounts; we manage money for the pension plan participants and for direct individuals. Many people have spent their entire life to create some wealth or to save the money that they entrust with us. We believe that our job is first to protect their present assets and then to enable their future by growing that money over time.
Our flagship product is the Polen Growth Fund, which we launched in 2010. It is in fact an implementation of our broader investment strategy, the Focus Growth strategy, which has been in place since 1989. So, the strategy has a long history as we have been managing it since 1989 before extending it into the mutual fund.
In more recent years, weíve expanded from a U.S.-focused product to a global and an international growth strategy. The only difference between the three products is the geographic skew. The flagship Focus Growth strategy is invested in businesses based in the United States, although it has some ability to invest in companies domiciled abroad.
The International Growth portfolio has the opposite mandate; it invests in companies strictly outside of the U.S. The Global Growth strategy is a collection of the best businesses in the world. I am the co-portfolio manager of the Polen Growth Fund and also the co-portfolio manager of the Global Growth strategy.
Q: What are the unique features of the fund? What differentiates it from its peers?
Our main differentiator is the concentration of our products. Polen Growth Fund has about 20 holdings, while the Global Growth and International Growth funds are slightly more diversified with about 30 holdings each.
We view concentration as a big advantage from a return-generating and a risk-management perspective. The concentration allows us to reduce risk, because we invest only in what we believe are the best businesses, which tend to be less risky over time. Since its inception in 1989, the strategy has been a lot less volatile than its peers, as measured by standard deviation. It has shown better risk characteristics, especially on the downside.
Another differentiator is that our average holding period has been about five years. We make each investment with that horizon and thatís also a big advantage. Since inception, we have owned only 110 companies in the flagship Focus Growth strategy. We donít try to generate returns through repeating the process of buying low and selling high. Instead, we identify the 20 business that we believe are the best, pay a fair price for them, own them over time and let the underlying earnings growth drive the returns.
Because weíve owned so few companies, we can actually go back and decompose our performance. In short periods of time the market could be out of sync with fundamentals, but if we stretch the horizon out, it is the earnings growth that drives the performance.
Q: What core beliefs drive your investment philosophy?
We believe that we invest in businesses, not in stocks. It requires a different mentality to own a business than to trade a stock. Quality matters, because we believe that the business results do drive the performance over time. Our goal is to deliver solid double-digit investment returns through each of our products, while taking less risk.
Both growth and quality are important as we aim to deliver mid-teens returns in a steady, dependable and low-risk fashion. We donít make market calls or time the market. For us, owning a concentrated portfolio of quality growth businesses is the best way to protect the capital of clients while enabling their future. We donít try to outsmart the market or our peers; we just try to do a steady and solid job for the investors who have entrusted us with their capital.
Q: How does this philosophy translate into your investment process?
We are predominantly a bottom-up manager. Of course, we follow the macro developments, but our construction process isnít driven by a top-down view. We start with a broad universe of thousands of companies, but we quickly and efficiently limit that universe to about 300 companies. We narrow it down by applying five investment guardrails. We look for companies with return on equity, or ROE, of at least 20%, strong balance sheets, stable and growing profit margins, above-average growth of earnings and free cash flow, and organic revenue growth.
These five criteria remove many of the low-quality, mediocre businesses. Then we further downsize the list of 300 names to create our coverage universe of 100 to 150 companies. Because our goal is to own structurally great growth businesses for a long time, we exclude the highly cyclical and economically sensitive businesses and the businesses that donít have sustainable competitive advantages. We invest with a five-year time horizon, so if we are not confident in the sustainability of the business, we wouldnít invest.
Once we get our coverage universe, the next step is the due diligence, which involves reading reports, 10-Ks, regulatory filings, listening to investor presentations, etc. The goal is to understand what the business is about, why it is special, what its growth prospects are, etc. Through that repetitive process we select our best ideas.
Then an analyst does the initial research project, which represents analyzing the business, its advantages and risks, its growth, the developments in the industry, how it compares to its peer group and whether it meets our investment guardrails. That process is a high-level framing, which enables us to decide whether the business is interesting enough to go deeper. After the analysts publish their initial research insights, the portfolio managers and the director of research review them and provide feedback.
If we decide that the idea is interesting, we proceed to more presentation and discussion around the team. We have a team of 10 generalists and thatís on purpose. Nobody is just the biotech analyst or the technology analyst; we all cover companies across the spectrum and we can all participate in a discussion. Thatís how we leverage the team and get different perspectives and insights.
Our further research, or the iterative deep dive research, focuses on answering questions from the presentation and discussion process and on getting better clarity to make an investment decision. Although valuation is important for us, we put it at the end of the process. We donít start our process looking for cheap opportunities. Instead, we start with studying all the great businesses that we might want to own over the next five plus years. Once we know that we would like to own them, we focus on the valuation.
The portfolio managers of the Polen Growth Fund make the final decision together. We continue to monitor the business to make sure the investment is on track and to understand any new risks that might develop.
Q: What types of businesses do you exclude?
In essence, we exclude everything that doesnít meet our investment guardrails, including the ROE of 20% and better than average growth. We are diligent about these guardrails. For example, we find many SaaS software companies that are growing at attractive rates, but make almost no money. They are heavily investing in marketing to get more subscribers, under the premise that some day they will make money. That type of business is not for us. We are disciplined about investing only in companies that make money and have high return on capital.
From a philosophical point of view, we implement ESG throughout our strategies. So, we donít own tobacco companies, firearms or payday lenders.
Q: What is the rationale behind the hurdle of 20% ROE?