Interview on the Entrepreneur Podcast Network

We recently were interviewed on the Entrepreneur Podcast Network.  We provided some background on our firm and some financial advice for those looking to start a business.

Our Recent Interview With the Wall Street Transcript

HFP WST Interview 2012 - 

 (Disclosure: As of this date the authors and clients of Harvest Financial Partners own Cisco Systems, Expeditors International and Norfolk Southern. Positions may change at any time. These are NOT recommendations. This blog is for informational purposes only)

Checking Your Social Security Benefit Estimate Online

The Social Security Administration is now making your estimated benefits statements available online.  To save money they stopped mailing statements last year, though they resumed mailing them this year if you are 60 or older.  They will also mail a paper statement in the year you turn 25 with a notice to login online.  Here is a link to the press release describing the change.

The estimated benefit statement is the statement showing your annual earnings history and your estimated monthly payment if you retire at your “full” retirement age (based on your year of birth), or if you retire early, at age 62 or defer to age 70 in today’s dollars. It also tells you what your survivor benefits will be and your benefits if you become disabled.

Here is the link to the site to register; you will need to answer a few questions to authenticate your identity. It took me about 5 minutes to complete the registration process and it reminded me how much of one’s life is public knowledge.

We suggest you periodically go to the site to review your earnings history and make sure it is at least roughly correct.  From a planning perspective, it is a very good idea to know your estimated benefit amount.  It will help you and your advisor in making investment or retirement planning decisions.  But it is a very rough estimate as the Social Security Administration points out.

Jensen Quality Growth Fund

On May 21^st, we spoke with Robert McIver, one of the portfolio managers of the Jensen Quality Growth Fund. He  discussed Jensen’s stock picking process and elaborated on why the Jensen fund experienced a downturn in the recent quarter.

We have written about Jensen in the past, but let us start by reviewing Jensen’s process:

Step 1: Jensen sifts through 5,000 publicly traded companies and narrows the universe down.  To be included, stocks must have market capitalizations above $1 billion and a 15% Return on Equity (ROE) each year for the previous ten years. The 15% ROE requirement is a very strict one. Recently Jensen dropped AMETEK from its portfolio because its ROE declined to 14.8%. Mr. McIver also emphasized that the 15% ROE must be consistent over 10 years. To cite an example, Apple’s ROE has been over 15% for 7.5 years. Although Apple is a robust company, Jensen won’t consider it for another 2.5 years.

Step 2: Jensen then looks at the 200 – 250 companies that meet those two criteria and selects those with the strongest combination of growth potential, consistency and strength of margins, business returns, financial strength, and other quality characteristics. That narrows the field down to 50 stocks.

Step 3: Jensen then does additional fundamental analysis, seeking companies with substantial and sustainable competitive advantages, growth drivers, and free cash flow potential.

Step 4: Jensen chooses 25 to 30 companies to include in their portfolios that have both these high quality characteristics and that can be bought at very attractive valuations.  Individual positions are between 1% and 7%.

Currently, the average market cap in the portfolio is $62 billion and there are 30 holdings.

Turnover is low in part because Jensen places such a premium on sustainability of a company’s competitive advantage through the ten years of over 15% ROE.  Currently Morningstar calculates a 7% turnover ratio.  Jensen’s buying process is numerically selective; similarly its maintenance and selling process is also very qualitative. Jensen’s investment team consists of various business executives who have managed companies themselves. When the investment team disapproves of companies’ management decisions, they will sell the stock. Mr. McIver gave us three examples of recent stock sales.

·         Johnson and Johnson was sold from the portfolio because management responded poorly to some operational difficulties. Furthermore, the company’s drug pipeline appears too thin to combat its growing number of patent expirations making it harder to generate sales growth.

·         Clorox was sold from the portfolio because the company did not have much exposure outside of US markets. Also, management’s acquisition of Burt’s Bees was integrated poorly and, in Mr. McIver’s opinion, destroyed shareholder value.

·         Sysco Foods was sold because Jensen felt management’s decision to invest in their distribution centers was an inefficient use ofcapital.  

Mr. McIver also mentioned that Jensen’s decline in the recent quarter was simply a result of stock market forces. According to Rob, the companies that Jensen invested in were financially healthy and making correct operational decisions. However, the companies’ stock prices diverged from the companies’ actual performances. Essentially, there was a disconnect between companies’ performances and their stocks’ performances.  Jensen remains very comfortable with its holdings.

 All in all, Jensen is a reputable firm that provides solid long term returns while minimizing risk. Its dedication to fundamental investment strategies helps it weather the toughest economic impacts and come out even stronger.

Returns through 5/31/2012

	YTD	1 Year	3 Years	5 Years	10 Years
Jensen Quality Growth	3.37%	-5.04%	13.19%	1.14%	3.35%
S&P 500	5.16%	-0.41%	14.92%	-0.92%	4.14%

Source: Jensen Management

Assistance on this post was provided by

(Harvest Financial Partners owns the Jensen Quality Growth fund in client portfolios and uses it as an investment option in a number of retirement plans where Harvest is the investment advisor.  The authors own it in their personal portfolios.  Positions may change at any time.)

Dodge & Cox International Stock Fund

We had a conference call with Dodge & Cox’s International Fund on May 30. We spoke to Tara Shamia a client services representative of the firm.  Ms. Shamia gave us a summary of how the fund operated and answered our questions concerning the fund’s investment processes and holdings, and risk management procedures.

Dodge & Cox’s International fund invests in companies domiciled outside the US.  The fund is low cost with an expense ratio of 0.64% compared to a category average of 1.41%.

Dodge & Cox does extensive fundamental research on potential investments.  That research is done by a team of 22 analysts using bottom-up stock-picking methods.  Analysts are expected to be advocates for their investment ideas and present them to a 9 member investment management team led by Diana S. Strandberg. The investment team is experienced and stable; the average tenure of members of the Investment Committee is 22 years. 

Dodge & Cox as a firm follows a value oriented investment strategy looking to buy well established companies at attractive valuations.  They build the portfolio one stock at a time without regard to index weightings.  The firm currently believes that they are finding “compelling valuations” overseas pointing to strong company fundamentals and dividend yields above 4%.  They think the macroeconomic concerns about Europe and slowing Chinese growth are depressing equity prices below fair value.

The firm reviews how companies allocate their capital to determine how shareholder focused management appears. This explains why the fund is underweight the Eastern countries of the Asia-Pacific region, specifically Japan and China. Ms. Shamia explained to us although Japanese companies exhibit many positive traits like low valuations, they often put very low emphasis on shareholder value. In a similar vein, Ms. Shamia described that Chinese companies often fail to recognize the needs of the shareholders. She pointed out that many Chinese companies exhibit poor corporate governance; a similar refrain we have heard from other fund managers.

The fund will invest in both developed and emerging markets.  As of quarter end, the fund had about 20% of its $40 billion portfolio allocated to emerging markets. The emerging markets exposure has been coming down as valuations look less compelling.  David Herro, of Oakmark made a similar point when talking about his International Fund and International Small Cap Fund.  Both Dodge & Cox and Oakmark feel valuations in the developed markets are extremely attractive.

Currently, the fund is overweight in the telecommunications and financial services sector. Dodge & Cox sees strong growth prospects for communications and media companies in emerging markets and believe that entertainment and news distribution services are in high demand.

In the financial services sector, Dodge & Cox believes that European banks have bolstered capital ratios, reduced their holdings of toxic assets and trade at low valuations, in part because of low expectations placed on them by investors.

Dodge & Cox also doesn’t have sector or weighting guidelines for risk management. The firm measures risk not by market volatility but by the potential for investors to lose their capital. Dodge & Cox’s investment team tries to fully understand the companies that they are invested in and maintains a moderately diversified portfolio.  At quarter end the fund had 89 holdings with about 29% of the fund invested in its top ten holdings.  The firm is also very fully invested with a cash position of about 1.2% of fund assets.

While volatile, we continue to find the fund an attractive vehicle to invest in international markets.  In addition, the fund’s low expense ratio is another positive.

Returns through 3/31/2012

	YTD	1 Year	3 Years	5 Years	Since Inception*
Dodge & Cox International Stock Fund	12.72%	-7.61%	22.20%	-2.07%	7.75%
MSCI EAFE index	10.86%	-5.76%	17.13%	-3.51%	3.71%

Source: Dodge & Cox

* Inception is 5/1/2001

Assistance on this post was provided by DiAn Zhu

(Harvest Financial Partners owns the Dodge & Cox International Stock fund in client portfolios and uses it as an investment option in a number of retirement plans where Harvest is the investment advisor.  The authors own it and other Dodge & Cox funds in their personal portfolios.  Positions may change at any time.)

Oakmark International Small Cap Fund

David Herro, the fund manager of the Oakmark International and the Oakmark International Small Cap Fund, recently hosted a conference call to discuss both funds. Below we summarize what we think were some of his key points, specifically as they relate to the Small Cap fund.

The International Small Cap Fund has assets under management (AUM) of about $1.6 billion. It is a relatively low cost fund with an annual management fee of 1.15%. Morningstar calculates that the average fund in the category has an expense ratio of 1.38%. The fund currently holds 60 equities.

Herro invests in companies that he believes trade at a substantial discount to what he considers to be their true business value (which is the approach employed by all the investment professionals at Harris Associates, the fund’s investment manager).  Every stock purchase is viewed as if they were buying a piece of a business, not just a stock certificate. Having a smaller portfolio (15-60 stocks, for example, rather than 100-150) is important to Oakmark’s investment philosophy. By building focused portfolios, their managers' best ideas can have a meaningful impact on investment performance.

Stocks in the International fund are selling at 50% of Herro’s valuation and stocks in the International Small Cap fund are selling at 53% of Herro’s valuation. Oakmark’s preferred method of valuation is a discounted cash flow model. (They will use also use other methods such as sum of the parts, but they prefer discounted cash flow.)

With these valuations, Herro finds the current environment a unique opportunity to buy stocks at extremely low prices. After the market crashed during 2008-2009 investors moved toward bonds because they feared that events would continue to spiral downwards, but conditions have improved. Macro issues have continued to cause share prices declines but have not impacted companies’ overall business performance.

Herro says it is somewhat more difficult to find good, undervalued situations currently. He views emerging markets as fairly valued, with developed markets selling at low prices, so he is focusing on developed markets.  Herro believes the best scenario is to find well-priced developed market stocks that are growing their business in emerging markets. This also provides additional corporate governance protection. To Herro, what’s important is how the company makes its money and how it’s priced, not where it’s located.

Herro believes that a meltdown of sovereign debts is highly unlikely in France, Spain, and/or Italy, and also doesn’t see it as a major long term issue. Banks are selling at half of book value in Europe, which represents good value in his opinion. In Japan, they are selling for just under book value, so Herro believes it’s less attractively priced than Europe.  Even at that valuation, financials are an underweight in the International Small Cap fund. 25% of the International Small Cap Fund’s holdings are based in Japan with a total of 43% throughout Asia.

We continue to like the Oakmark International Small Cap Fund.  The fund’s research-driven, consistent pursuit of the best values overseas coupled with its compact portfolio shows us some of the attributes that we look for in our active fund managers. While volatile, we think the fund is an excellent option to obtain exposure to smaller capitalization international stocks.

Returns through 3/31/2012

	YTD	1 Year	3 Years	5 Years	Since Inception*
International Small Cap	17.77%	-1.97%	32.46%	-0.85%	10.51%
MSCI World ex-US Small Cap	10.37%	-7.38%	25.41%	-2.11%

Source: Oakmark

* Inception is 11/1/1995

Assistance on this post was provided by Grace Guo

(Harvest Financial Partners owns the Oakmark International Small Cap fund in client portfolios and uses it as an investment option in a number of retirement plans where Harvest is the investment advisor.  The authors own it and other Oakmark Fund in their personal portfolios.  Positions may change at any time)

Oakmark Equity & Income Fund

Clyde McGregor, the fund manager of the Oakmark Equity Income Fund, recently held a conference call covering the period ending March 31, 2012. Below we summarized what we thought were some of his key points.

McGregor invests in companies that he believes trade at a substantial discount to what he considers to be their true business value (which is the approach employed by all the investment professionals at Harris Associates, the fund’s investment manager).  Every stock purchase is viewed as buying a piece of a business, not just a stock certificate.  Also, having a smaller, more focused portfolio of stocks (15-60, for example, rather than 100-150) allows the manager’s best ideas to have a meaningful impact on investment performance.

The Equity and Income Fund has assets under management (AUM) of about $20 billion. It is a low cost fund with an annual management fee of 0.67%. Morningstar calculates that the average fund in the category has an expense ratio of 0.77%. The fund currently holds 53 equities.  Its asset allocation is about 70% stocks and 30% bonds; representing the highest equity weighting the fund attains.

The Equity and Income Fund is an all-cap fund on the stock side with the 21 person research staff going wherever value takes them. The highest market cap stock in the fund is about $207 billion and the lowest $306 million. During this quarter, the median market cap of the fund reached a new high of $9 billion.  At quarter’s end 62% of the portfolio was invested in large cap stocks with 14% of the equities being international.

The fixed income or bond portion of the fund is composed of 13% US Treasuries, 9% non-US sovereign debt, 7% in Treasury Inflation Protected Securities (TIPS), 1% in corporate bonds and just a sliver of agency debt.  The duration of the fixed income portfolio is a short 1.65 years.  (Duration measures sensitivity to interest rates.  Technically, if interest rates were to rise by 1%, the value of the fund’s bond holdings should decline by 1.65 %.)  They have kept duration short for some time now.

The fund was up 8% for the quarter ending March 31 about even with its peer group. The fund was underweighted in a few stronger market segments - financials and technology – but benefitted from good stock selection in names like United Health, Diageo, Texas Instruments and TJX.  

The fund added 8 new equity names to the portfolio while selling 4; they sold 3M, Sara Lee, L3, and Tractor Supply.  The eight new additions during the quarter were: Ebay, Illinois Tool Works, Parker Hannifin, Republic, Staples, Ameritrade, Lear, and Northrop Grumman. Unfortunately the buying window on a number of these stocks was very small so the fund was unable to build very large positions.  This also had the effect of lowering the turnover of the fund to 30% (turnover for the average fund in this category is above 60%).

One fund holding, Pentair, is going to merge with a division of Tyco international. Pentair is going to be the name of the combined firm while Tyco shareholders will own a majority of the new company’s shares.

McGregor noted he has been trying to add income to the portfolio without overpaying for it, which he stated has been difficult because “income is overpriced today,” a distortion he believes is created by the Federal Reserve.  He also mentioned that he does not find a lot of value in Real Estate Investment Trusts (REITs) or Master Limited Partnerships ( MLPs)two sectors that yield-focused investors have long found attractive given that their unique tax structure which has led to higher distributions.

In the current environment with extremely low interest rates (that are likely to rise) and companies at average valuations (as measured by PE ratios), McGregor expects that equities will likely not advance much going forward.  He did point out that today American business and industry is managed much better than the recent past with technology helping managers run their businesses more effectively resulting in greater profitability than in the past.  This could be more supportive of valuations expanding.

While the fund has had a 10.94% average annual return since inception, McGregor thinks it more realistic to expect mid to single digit compound rate of returns going forward. While he will work very hard to maintain that 10% return going forward it would require a substantial return from stocks given low bond yields.  For the reasons given above he expects that to be unlikely.

We continue to like the Oakmark Equity & Income Fund.  The fund’s research-driven, consistent pursuit of the best values in United States and overseas equity markets coupled with a protective high-quality bond portfolio has generated solid returns with much less volatility than an all stock portfolio. We think the fund is a relatively conservative way to get stock exposure. We view the fund as an attractive investment option for retirement plans and a core fund for many of our clients with smaller account balances.

Returns through 3/31/2012

	YTD	1 Year	3 Years	5 Years	Since Inception*
Equity and Income	7.91%	3.74%	14.89%	5.32%	10.59%
Lipper Balanced Index	7.88%	4.60%	16.79%	3.04%	6.62%

Sources are Morningstar and Oakmark

* Inception is 11/1/1995

Assistance on this post was provided by Grace Guo

(Harvest Financial Partners owns the Oakmark Equity & Income fund in client portfolios and uses it as a default investment option in a number of retirement plans where Harvest is the investment advisor.  The authors own it and other Oakmark Fund in their personal portfolios.  Positions may change at any time)