A Tale of Two Moats
How two funds met very different fates due to the quality of their holdings.
Schneider Value and Jensen Fund (JENSX) are among the best at executing distinctive strategies; they charge reasonable levies, come from seasoned boutique managers, and have earned our Analyst Pick designation. Both funds focus on large-cap stocks, differ from common benchmarks, and hold concentrated portfolios.
Yet that's where the similarities end. If you were to consider only the fund's Morningstar Style Box placement, Jensen in large growth and Schneider in large value, you might think Jensen is the riskier fund because it's willing to pay up for some growth. Yet reality tells a different story--witness the funds' performance in the last bear market and ensuing rally:Cumulative ReturnsJensen (JENSX)Schneider Value S&P 500Bear Market 10/9/07 to 3/9/09-45.30%-70.80%-54.90%Rebound 3/9/09 to 2/20/1190.20%148.10%104.40%
Schneider Value suffered big losses during the tumultuous environment between late 2007 and early 2009 and has sprung back with a force ever since. Jensen experienced a much more moderate ride, losing less than the S&P 500 on the way down and not quite matching it on the way up. Jensen and Schneider frequent the top or bottom quartiles of their categories in any given year. Yet in years when Schneider's on top, as was the case in 2003 and 2004, Jensen is usually lagging--and vice versa. Over longer periods, both funds have posted compelling absolute and relative returns, yet Jensen usually ekes an advantage during tough environments, whereas Schneider has achieved its success with short bursts of extraordinary outperformance.
The root of the funds' divergent paths can be summed up in one word: "Quality." A company's quality characteristics were far bigger drivers to performance than growth/value, small-cap/large-cap, or sector classifications in the last three years. Buying quality companies with long histories of high returns on equity is the cornerstone of Jensen's strategy. Schneider, on the other hand, is a deep-value fund whose manager is drawn to the most controversial industries and companies operating well below normalized earnings in search of killer values--Warren Buffett would refer to them as cigar butts.
To help us assess the quality of a fund's underlying holdings, we look to our team of equity analysts who cover approximately 2,500 stocks and assign each a moat rating of wide, narrow, or none. The term "moat" was first applied to investments by Buffett and refers to the moats that surrounded castles and made it harder for enemies to overtake them; the wider the moat, the harder to cross. The size of a company's moat signifies Morningstar analysts' assessment of how well and for how long a company can keep competition at bay and earn excess returns on invested capital. Rolling up the moat ratings of a mutual fund's individual stocks gives us new perspectives on that portfolio and its strategy in action. The moat characteristics of these two funds are summarized below:MoatJensen (JENSX)Schneider Value Wide72%0%Narrow26%51%None0%40%Portfolios dated 9/30/2010.
It's no surprise to see that Jensen hasn't invested a single penny in companies without moats and that a large portion of assets sit in wide-moat firms. It's also not a surprise to see that Schneider Value has the opposite profile--nothing in wide-moat stocks and a large chunk of its portfolios in firms with narrow moats or no lasting competitive advantages. The deep-value discounts and below normalized earnings that epitomize manager Arnie Schneider's strategy don't tend to turn up in wide-moat companies.
The drastically different profiles for these two funds aren't new. In the middle of 2008, Jensen owned large stakes in wide-moat, blue-chip companies with fortress balance sheets. Johnson & Johnson (JNJ), Procter & Gamble (PG), and Microsoft (MSFT) graced its top 10. Investors fled riskier fare in favor of the safety of such firms in 2008 and early 2009, cushioning their losses. Meanwhile, Schneider was dipping deeper into the heart of the most distressed industries and companies: Arch Coal (ACI), Fannie Mae (FNMA), and Freddie Mac (FMCC) held top spots in mid-2008. Investing in the midst of thick controversy and investor fear has worked wonders for Arnie Schneider over numerous market cycles. For example, he owned a large position in airplane maker Boeing when travel slowed down dramatically following 9/11 and planes--old and new--sat idle. The Boeing position predated Schneider Value's 2002 inception in his separately managed accounts and played a key part in its early portfolios. In fact, the bets Schneider was making in the last bear market have fueled a compelling longer-term track record despite the fund's recent bear market slide; it is still up more than 10% annualized since inception, nearly 2 percentage points better than the S&P 500.
Without the moat lens, it may have been hard to discern what was going on with these two funds and others like them. The answer did not lie in the traditional growth versus value or technology versus financials dimensions. By considering moats in addition to those measures, the picture comes into clearer focus and helps investors better discern what they own and how to blend strategies together for well-rounded portfolios. To see moat data, you can click through the holdings of funds you are researching. We're looking to summarize moat data at the portfolio level at some point in the future.
There's no one right way to skin a cat, so Jensen and Schneider Value remain Analyst Picks for excelling at what they do best; their differences can actually make them useful complements to each other in a portfolio.
Karen Dolan has a position in the following securities mentioned above: PG, JNJ. Find out about Morningstar’s editorial policies.