Q: What is the mission and history of the fund?

Our stated mission is to: “Preserve and grow client assets to protect their present and enable their future.”  We don’t 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, we’ve 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 that’s also a big advantage. Since inception, we have owned only 110 companies in the flagship Focus Growth strategy. We don’t 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 we’ve 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 don’t 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 don’t 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 isn’t 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 don’t 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 wouldn’t 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 that’s 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. That’s 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 don’t 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 doesn’t 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 don’t own tobacco companies, firearms or payday lenders. 

Q: What is the rationale behind the hurdle of 20% ROE?

Philosophically, we believe that the best way to drive returns over time is to own economically superior businesses that deliver that type of return. That’s the meaning of the ROE threshold. I am not saying that we wouldn’t consider a company that consistently delivers ROE of 19%, so there isn’t any magic about the number. But we have to draw a line somewhere.

The average American company has a return on equity of about 12%, so 20% is above the norm is a healthy hurdle. Back in 1989, the guardrails were laid out by the founder and have been the place since the fund was established.

Q: Is the ROE hurdle based on historic averages or on expected returns? Could you give us some examples?

We look for sustained characteristics and for businesses that can sustainably meet our criteria over time. We don’t look for companies with no history of making money, which all of a sudden are delivering returns, but we don’t exclude that possibility either. Facebook, Inc would be an example of a company, which wasn’t earning much five years ago, but now is delivering strong returns and has exceptional economics, despite the current challenges. 

Adobe Systems Inc would be another example. It has been a long-term leader in digital media with remarkable returns and solid growth. However, its business model shifted from selling boxed software to a subscription model. Because of the transition, which started in 2011, the company wasn’t profitable and didn’t have the desired ROE. 

As they moved through the transition and the economics started to come back, we made an investment before Adobe fully reached the 20% ROE threshold. We could see that the profit impairment was strictly due to a temporary shift in the business model. Now Adobe has a ROE of above 40% and strong growth over the past several years. It has been one of our largest holdings and leading contributors.

We put a lot of weight in the guardrails in the process, because if a business meets all of them, that’s a good indication that there are competitive advantages, properties and qualities in the business that are worth considering.

Q: What is your view on hardware companies? Do you tend to avoid them?

Because of our focus on free cash flow, we tend to favor businesses that are not capital intensive. We don’t lean heavily towards hardware since it tends to be commoditized over time and has more pricing pressure. The commoditization of hardware is a challenge when you own a company for five or 10 years.

However, we have owned companies like Apple Inc for a long time. Apple was our largest holding in the period 2010 to 2012, but we don’t own it any more. To some degree, Apple has defied the rule of commoditization, but the industry is historically inclined in that direction.

We have a large position in Alphabet Inc and we owned Qualcomm in 2008 through 2014. The stock did well and we sold it because in 2014 Qualcomm was becoming more dependent upon emerging markets. At the time, the developed world had high cell phone penetration and the market was driven mainly by China, which was moving to 4G standards and had to adopt Qualcomm’s technology for the first time. There were high-level negotiations by competitive boards and we saw some manufacturers in China not paying royalties. We became concerned that Qualcomm had evolved into a moderate growth company, highly dependent upon China, and we had concerns for this market. For us, that was too much risk to bear, so we moved on. 

That’s a good example of our risk management, which shows that even the best businesses can see new risks. If we see a small chance for a big problem, we are quick to get out. That’s part of our risk discipline. As a concentrated manager, we take substantial positions in anything that we own. So, if we are not comfortable with the risk, we would rather not own the company.

Q: Would you describe your portfolio construction process and the role of diversification in it?

Our primary benchmark is the Russell 1000 Growth Index, but we are benchmark agnostic in the construction process. With a concentrated portfolio of 20 holdings, we deviate from the benchmark positively or negatively in the short term. However, over a meaningful period of time, the portfolio is set to deliver higher growth than the benchmark.

We invest across the entire growth spectrum. At the lower end, we look for businesses that can at least do better than the market. That means high single-digit returns of 6% nominal growth plus 2% to 3% from dividend yield. So, at the safer end of our portfolio, we would own companies like Oracle, Accenture or even Microsoft, although the latter is recently defying these growth rates.

On the other end of the spectrum, we would invest in companies like Adobe, Align Technology or Facebook, which have been delivering growth of 25%, 30% or more, and companies that we believe would continue to deliver for a period of time. Then we have everything else in between. These different growth companies blend together to deliver mid-teen underlying earnings growth for the portfolio. 

We build the portfolio one company at a time and we are extremely careful about the quality in every link of the chain and in the aggregate portfolio that we try to create. Typically, if we want a position, we want a full position. Most of our holdings are between 4% and 5%, which we consider a full weighting. We also have positions with higher weight, because we let the winners run. Today the larger positions in the portfolio are Adobe, Microsoft and Alphabet. There aren’t many names that are substantially less than 4%. 

Historically we’ve been overweight in technology, healthcare and consumer industries. We don’t have much exposure to financials, certainly not to traditional banks and insurance companies, but we own companies like Visa or MasterCard, which don’t have the balance sheet risk of other financial institutions. We’ve never owned materials, energy, utilities or telecom companies. Our sector and industry exposure is the result of our philosophy to search for the best businesses; we just happen to find the best businesses in certain areas.

Q: What is your sell discipline? Why would you sell a stock?

There are several reasons that would trigger a sell decision and have a strict discipline, which has kept us out of risky situations. We don’t own Netflix or Amazon, which have tremendous share price returns, but also have high valuations. So, we are disciplined about what we own.

The first reason for selling a stock would be the emergence of a new risk or a threat to the competitive advantage, as in the case with Qualcomm. Another reason would be the deterioration in fundamentals. If a business stops meeting our guardrails, if profitability declines and economics deteriorate, if there is a product shift or an excessive investment cycle, we would typically prefer not to remain invested in the situation.

We also have a valuation discipline. If the equation between growth and multiples starts to stray, then we will sell. Sometimes the business is doing great, but the valuation reaches a point where we can’t remain comfortable and confident that we will get the expected double-digit return. Finally, there are portfolio construction considerations. We always look for better ideas and consider the aggregate portfolio characteristics. We make sure that we are diversified across drivers more than across sectors.

Q: How do you define and manage risk?

Risk is the permanent impairment of capital. We focus on both quality and growth, but we stress quality more than growth. Sometimes we may accept slightly lower growth, but we never compromise on the quality. There are periods with slower growth opportunities at a better price and we embrace them. At other times quality and growth companies become overpriced and we have to stick to our discipline to invest only in quality. 

We first need to protect our investors, but we know that we can produce solid double-digit returns over time, and we are happy to do that in a dependable fashion. We don’t reach for the extra return that would result in taking more risk.