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A Fund’s Smart Bets on Microsoft, Mastercard, and Visa

Sarah Max January 25, 2019 | Barron’s

Dan Davidowitz. Photograph by Kayla Mendez

It is surprising, perhaps, that the $2.7 billion Polen Growth fund took top honors in Barron’s ranking of sustainable mutual funds published earlier this month. But it isn’t accidental. While the 20-holding fund doesn’t bill itself as ESG, or focused on investing with an eye toward environmental, social, and governance issues, “we’ve always looked for businesses that have many of these qualities,” lead manager Dan Davidowitz says, noting that companies with strong financial performance often have the resources to be good stewards and employers.

The same might be said about Polen Capital, whose founder, David Polen, developed the strategy that governs the fund, which returned more than 7.5% in 2018, outperforming 97% of its Morningstar large-growth peers. After Polen died in 2012, Davidowitz, his co-manager, Damon Ficklin, and CEO Stan Moss sought to develop a culture that would ensure that the Boca Raton, Fla.–based firm would not only survive its patriarch, but also thrive.

Inspired by the book Why Work Sucks and How to Fix It, by Cali Ressler and Jody Thompson, they emphasize a results-oriented environment with many employees working remotely or on flexible schedules. “I’m not going to tell my team they have to read 10-Ks in this little box between the hours of 8:30 a.m. and 5:30 p.m. five days a week,” says Davidowitz, who started his career in public health.

Read more: A Q&A With Polen Gowth Fund’s Dan Davidowitz

Among other benefits, employees receive an annual $5,000 stipend for courses or workshops that help them improve professionally or personally. The firm has embraced Enneagram personality testing and training, based on the logic that recognizing personality traits and differences improves communication. It might sound hokey, says Davidowitz (a No. 2, or helper, in Enneagram parlance), but it hasn’t hurt business: Since 2012, assets under management have swelled from $3.5 billion to $21 billion.

The Polen Growth mutual fund was launched in 2010 and follows a high-conviction, low-turnover strategy developed 30 years ago by David Polen. Since then, vehicles managed according to this strategy have owned only 120 stocks.

Investors often associate concentrated portfolios with above-average volatility, but Polen’s results challenges that view. The S&P 500 lost nearly 40% of its value peak-to-trough from the tech bubble’s bursting in 2000 through 2002. But the strategy fell 14% in that time. In 2008, it declined 27% versus 37% for the index. In the past five years, the fund’s investor-class shares (ticker: POLRX) have returned an average of 13.4% a year, better than 98% of Polen Growth’s large-growth peers, and nearly four percentage points, annually, ahead of the index.

Polen Growth

*Annualized. Returns as of 1/22/19; holdings as of 12/31/18. Source: Morningstar

Davidowitz, Ficklin, and their team of eight other portfolio managers and analysts generally won’t look at a company unless it meets five criteria: a cash-rich balance sheet with little debt, adequate free cash flow to fund acquisitions or return capital to shareholders, a sustainable return on capital of at least 20%, flat to increasing profit margins, and revenue growth that is independent of economic or industry cycles.

“Each one of those is a pretty high hurdle, but when you put all five of them together you end up with a very small group of companies,” says Davidowitz.

Of the roughly 1,000 large-cap companies in this fund’s universe, 250 might make the initial cut. From there, the team whittles down the roster through research. Holdings are diversified across the growth spectrum, and range from top performers, such as Starbucks (SBUX) and Regeneron Pharmaceuticals (REGN), to what David Polen called “safeties,” including such stable growers as Accenture (ACN), O’Reilly Automotive (ORLY), and Dollar General (DG), to name a few.

One of the fund’s largest holdings, Microsoft (MSFT), is also a safety, although its recent trajectory puts it closer to the high-octane end of the spectrum. David Polen first bought the stock in 1992 and sold it in 2009 to make way for Apple (AAPL), no longer a holding. In 2017, Davidowitz and his colleagues saw new potential as Microsoft moved to a subscription model and changed its tune about collaboration with other companies. “This past quarter, organic revenue growth was 18%. It’s shocking for a company that big to be able to grow at that pace,” he says.

Credit-card giants Mastercard (MA) and Visa(V) are examples of the kinds of companies the team aims to own. In addition to healthy balance sheets and an abundance of free cash flow, both companies have a return on capital double the fund’s 20% requirement. Their costs are relatively fixed, so as transaction volume swells, profit margins do, too. “Mastercard went public in 2006 with operating margins in the midteens, and today it’s getting close to 60%,” Davidowitz says.

The fund has bought and sold both companies several times, most recently buying Visa in early 2013 at about $39 a share and Mastercard later that year at around $51—for annualized returns about 24% and 28%, respectively. The shift from cash to electronic payments has been driving growth for this duopoly, but there is still room to take a greater share of the world wallet. “Less than a third of global personal expenditures are electronic,” Davidowitz says.

Adobe (ADBE), in a different industry, is a similar story. “They really have a monopoly on digital-content creation,” says Davidowitz, whose fund has owned the stock since March 2017 at $77 a share. Adobe recently traded around $245. What changed: The company found a new gear in growth by shifting its business model from licenses to subscriptions. Now, it is expanding its reach from content creation to marketing and commerce via the recent acquisitions of Marketo and Magento Commerce. “Companies need good digital content creation for everything they do on the web,” Davidowitz says, “and Adobe is essentially the arms supplier.”

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