Q: What is the mission of the fund?

Polen Global Growth Fund was launched less than two years ago, on January 1, 2015. The Fund is one way clients can invest in our Global Growth strategy.

Our primary goal is to identify and invest in select high-quality companies capable of sustaining superior business performance over long periods of time, and by doing so, grow our clients’ investment with us through the power of compounding. 

Our benchmark is MSCI All Country World Index, but we are actually benchmark-agnostic because you can’t beat your benchmark if you’re too similar to it.

The firm has approximately $10.3 billion in assets as of September 30, 2016, nearly all of which are in our flagship strategy, the Focus Growth strategy. The Global Growth strategy currently comprises about $40 million and is available through different offerings, depending on our clients’ needs. Almost all the assets in the global growth strategy, roughly $37 million, are available in one of two vehicles: a mutual fund or ADR (American depositary receipt).

Q: How do you differ from your peers?

Primarily, four things distinguish us: portfolio concentration, the quality of the businesses we invest in, the long-term nature of our investments, and our risk management—the don’t-lose mentality we bring to the investment process. 

In terms of concentration, we have less than 30 holdings, all high-quality businesses from around the world and too good not to own, in my opinion, and we do this for two reasons: we strive to preserve client capital, first and foremost, and then seek to grow it safely. With this approach, I believe we are likely to outperform broader markets over longer periods of time. 

We also limit the portfolio to those relatively few high-quality businesses that tend to be larger cap and competitively dominant within their industries or competitive spaces. They’re growth-oriented, with high-quality financials, where there’s typically little or no debt on their balance sheets—sustainable growth driven by unit growth, and stable-to-increasing margins. These companies tend to generate large amounts of cash and free cash flow, relative to their accounting earnings. This means we invest in a distinctly small slice of the investable universe.

The third way we differ is through time. Once we assemble premium-quality businesses in the portfolio, they need time to compound. We expect investment returns to derive from compound growth in high-quality earnings per share and cash flow. We seek to roughly double our clients’ money every six or seven years, and achieve that through compound earnings growth.

The fourth point is management of risk, or “don’t lose.” We manage for absolute returns for our clients, not relative returns to a broader stock market, and we believe that a double-digit return is a realistic expectation over long periods of time. Therefore, everything we do is guided by a margin of safety. We are not necessarily looking for a discount to intrinsic value—we define margin of safety as the quality of the businesses that we invest in and how sustainable they are in their balance sheet strength.

Q: What is your investment philosophy?

Our philosophy is predicated on the belief and expectation that superior business performance drives superior investment performance over time, by way of compounding. We do not, for example, manage fixed-income strategies. 

We also believe in investing for our clients the way we do for ourselves, our families, and loved ones, and so we emphasize employee ownership in this portfolio.

Q: What is your investment process?

Our process is neither top-down nor is it just quantitative. Our investment team comprises, first and foremost, business analysts, and we actively investigate and research about 10% of the roughly 3,000 companies in our universe, both in the United States and abroad, that have the financial strength to make it through our screening process.

More detailed financial analysis is useful, but at a later stage of the process, and not without a strong, granular, qualitative understanding of the business. Often, our best ideas come from the research we do on other companies. 

Once we have identified potentially interesting candidates, we screen them. We have a number of financial measures or guardrails we look for, and are fairly strict about them, such as balance sheet strength and companies with little or no debt relative to cash flow. We also consider companies with underlying unit growth, with stable to proven profit margins, and look for high conversion of earnings to cash flow and sustainable return on capital.

Doing this swiftly shrinks our investable universe by about 90%. We then parse reported earnings and financial statements and assess the company’s history more closely, shrinking our investable universe further, to about 100–150 companies. 

At this point, one or more of our analysts re-research the company and the industry in greater depth, focusing on a specific competitive advantage as a way of sustaining return on capital— qualitatively, what enables that business to sustain its competitive advantage.

We study the management team, as great companies are generally managed by great people. We often meet with the company, even traveling to Europe or Asia, if necessary. Ours is a patient, thorough, lengthy, in-depth research process. Every holding in this portfolio is supported not just by the quality of the businesses we look at but also that of our research process, however long that might take. 

Sometimes we find the right business in the “wrong” part of the world, or in the wrong industry, or headquartered in a country that prevents compounding from working effectively, because there may be excessive macro risk. We strive to avoid macro risks that interfere with the compounding process. 

For example, there are a number of emerging markets featuring attractive businesses, but the macro risk, whether due to a less stable government and stewardship of the economy, structural currency weakness, or cyclicality, is more than we want for our shareholders. Accordingly, there are several sectors we typically do not invest in, like financials (especially banking) or the energy, industrials or materials sectors.

Because compounding is so critical to our strategy, we do not consider any investment with less than a five-year holding period. Holding periods, to us, are an essential driver of investment returns

Q: Can you illustrate your research process with an example?

One that recently left the portfolio is ARM Holdings plc, which designs computer chips used in mobile phones and is based in the United Kingdom. That alone makes it unusual in that it’s a leading technology company that isn’t based in the United States. Plus, for a company its size, it possesses an extremely dominant competitive positioning, with more than a 90% share of processing chip designs in mobile phones across the world. 

ARM doesn’t actually make anything. It designs chips and sells those designs to virtually every leading chip and some non-chip manufacturer. In other words, it’s a trusted partner and an independent supplier to most of an industry, and maintains an enormous competitive advantage, as its chip designs achieve a superior combination of processing power and battery life compared to any competitors, including Intel.

Despite this, the company only charges a modest amount for its designs. In an iPhone, for example, ARM’s designs are the brains, the processing power of the device, and is one of the reasons why iPhones today have more computing power than a super computer had in the mid-1990s or Apollo 11 had when it went to the moon, yet ARM will only receive a royalty of perhaps 35–40 cents on every iPhone sale.

This unusual business driving developments across the entire industry rose through our financial screens before we’d even launched our global strategy, and has compounded steadily for more than 10 years. 

We expected to own ARM for another five to 10 years, partly because mobile handsets and other mobile devices get replaced every few years, representing a potentially highly recurring revenue stream. We also expected further growth to come from the proliferation of smart technology, low-powered connecting devices, i.e., the Internet of things.

Finally, we expected ARM to gain market share in newer markets, including enterprise network equipment and server computers, where power consumption is a key consideration and a major element of the cost of ownership.

However, in the third quarter of this year, in a move that was welcomed by ARM’s board, SoftBank Group, based in Japan, a larger public company, made a cash offer to ARM‘s shareholders. We were sad to see it leave the public domain after having looked forward to five to 10 years of double-digit compounding.

Q: How do you construct the portfolio?

We are disciplined in both valuation and risk management. The portfolio remains highly concentrated over time, with a few different businesses competing for roughly 30 spots in the portfolio. 

There are a number of great businesses we research thoroughly with an eye to include them in the portfolio at some point, but they do not yet feature the kind of return we demand: an annualized absolute double-digit return over the next five years.

This is why we are benchmark-agnostic. There are far too many companies in the MSCI All Country World Index that do not represent the combination of quality and safety we look for. 

We consider investments one at a time. In a concentrated portfolio, every holding matters. There can be no marginal holdings.

We also invest across the growth spectrum, welcoming some faster-growing as well as slower-growing businesses. There are some that we expect to sustain about 25% earnings growth for at least the next five years, not unlike a Facebook or Adobe Systems.

Complementing the faster-growing companies we hold are companies with more modest growth rates, which may sustain compound earnings growth of only 10% to 12% over the next five-plus years, but may help to sustain the portfolio’s financial performance through different market cycles. What we want from our investments in these slower growth businesses is resilience - the ability to sustain strong levels of free cash flow generation throughout the market cycle, including the worst market cycles.

When we average those growth rates, we are seeing a weighted average earnings growth rate that indicates the portfolio is in a good position to perform relatively well, and well in absolute terms, for years to come.

Last but not least, we strive for a portfolio with a minimum position of about 2% and a maximum position is often roughly 6%, so an average of 3% to 3.5%. Again, it’s about sustainability—we want most of the portfolio to drive most of the returns. We’re not looking for rock stars. We want depth and breadth of earnings quality across all holdings.

Q: How do you view risk, and what steps do you take to manage it?

Our sell discipline is integral to our risk management, and virtually a mirror image of our buy-and-hold discipline. We want the entire portfolio to align with our criteria, our guardrails, at all times. When that changes, for example, if a management team takes on more debt, or a growth rate in the company is no longer adequate, the holding is immediately a sell candidate. I am decidedly clinical about sell discipline.

The most important reason for selling would be a threat to a company’s competitive advantage, but other reasons include a deteriorating fundamental outlook and growth rate, or, more simply, if we identify a better return to the portfolio.

Because we manage for absolute returns, and believe that a double-digit return is a realistic expectation over long periods of time, everything we do is guided by our margin of safety, the quality of the businesses we invest in, and how sustainable their balance sheet strengths are.

In terms of overall risk, our margin of safety is built into every step of our investment process. Our process is designed to avoid companies that tend to operate cyclically, such as companies with a lot of exposure to materials or government regulations. 

We also seek to avoid holdings in certain countries that pose that degree of macro risk I mentioned earlier. We strive for relatively low country risk, with a strong bias toward globally competitive businesses that tend to earn revenues in lots of different countries, a characteristic that is present in about 80% of the portfolio holdings today.

A key aspect to risk management lies in knowing our businesses well. We buy only competitively and financially superior companies that are hard to compete with, ones with balance sheet strength to weather different stages of the market and economic cycles. The entire portfolio, in aggregate, has more cash than debt.

We maintain additional hard limits on sector and country exposure, and our Risk and Compliance Committee provides an additional layer of oversight on everything the research team and I, the portfolio manager, do to minimize risk in the portfolio.