30 BARRON’S March9,2020
FUND PROFILE
Talking With Bill Nolinand Tom Rozycki,
Managers, Principal Blue Chip
think long-term and have significant insider ownership.
“Most of corporate America is not run that way,” he says.
“Especially, mid-cap and large-cap companies are run by
what we call cash-paid-for CEOs: people who don’t have a
large ownership stake and are mostly paid employees. At
such companies there is a strong pressure from Wall Street
to get results immediately.” Such short-termism leads to
executive decisions “that aren’t good for the business, but
good for the CEO” who is seeking a quarterly bonus.
But Nolin’s results are unquestionable. Blue Chip’s 14.8%
five-year annualized return beats 94% of its peers in Morn-
ingstar’s Large Growth category, as well as the 13.3% return
of its benchmark, the Russell 1000 Growth Index. And it
has done this with less volatility than both. Nolin also runs
the olderPrincipal MidCap(PEMGX), now closed to new
investors, which has trounced 97% of its peers in the past
Photograph byBARRETT EMKE
W
hen Bill Nolin was in elementary school,
his father quit his job to start a steel-fabri-
cation business. “This business was in our
lives daily, whether it was my mom run-
ning the accounts, or my dad coming
home at 5:30 p.m. with the pickup truck
loaded with boxes to ship or me helping
him put on the labels that my mom had prepared and
going to the UPS store,” says the manager ofPrincipal
Blue Chip(ticker: PBLAX). The business wasn’t just a
job to his parents. “It was something they loved; a pas-
sion or calling,” he says. “And they worked on it 24-7.”
Nolin, 51, seeks that kind of “owner-operator” pas-
sion from the executives of the companies in his fund.
He invests in businesses still run by their founders, or at
least where executives behave like founders—those who
By LEWIS BRAHAM
Managers
Who Act
Like Owners
March9,2020 BARRON’S 31
decade. (Although Blue Chip carries a 5.50%
load, large brokers such as Fidelity and TD
Ameritrade often waive that commission.)
Nolin is chief investment officer of an
11-member boutique subsidiary of Principal
called Aligned Investors, which manages
around $32 billion, including Blue Chip’s
$5.3 billion. He and co-manager Tom Rozy-
cki, 40, are supported by six investment
analysts devoted exclusively to the Aligned
subsidiary. Blue Chip was launched in 2012
as an offshoot of the boutique’s mid-cap
fund. “Our successful mid-cap companies
eventually became too large to own in our
mid-cap strategy,” Nolin says. “It made sense
to start a strategy where we could invest in
these larger companies.” Some of the “grad-
uates” from the mid-cap fund to Blue Chip
have included supermarket company
Costco Wholesale(COST), fast food res-
taurateurYum! Brands(YUM), and cell-
phone-tower giantAmerican Tower
(AMT), Nolin says.
One graduate, which MidCap sold after
16 years but Blue Chip purchased last No-
vember, is tax-software companyIntuit
(INTU). Its QuickBooks and TurboTax soft-
ware “are both so dominant,” Nolin says.
“People are trained in [the software] and
don’t want to switch.” The rise of the so-
called gig economy is increasing the number
of self-employed Uber drivers, etc., who
need QuickBooks to itemize their mileage
and depreciation expenses, he adds. “There’s
a long runway for QuickBooks,” he says,
noting there are 48 million small businesses
and self-employed Americans, and only a
7% penetration of that market for the online
software. Intuit has begun providing more
hands-on service via live video-chat advice
from its accountants, in a bid to take market
share fromH&R Block(HRB).
Nolin attributes much of Intuit’s success
to its dynamic founder Scott Cook, who re-
mains chairman of its executive committee.
“He still works with the people at Intuit be-
cause he’s a fanatic about making it easier
for people to use their products,” Nolin says.
“That’s how you end up being 15 times larger
than your nearest competitor.”
One metric Nolin employs to analyze
whether a company’s executives are truly
owner-operators is an “aligned ratio,” com-
paring their stock ownership to their annual
salary and other benefits. “At the typical
public company, the ratio is in the range of
three to six times, so maybe a CEO owns $6
million worth of stock and gets paid $2 mil-
lion a year—three times,” says Nolin. “A lot
of our companies, the ratio is 20 to 1, and we
have several that are 50 or 100 to 1, and
some that are 2,000 to 1.”
Then there’sAmazon.com(AMZN), the
fund’s largest holding at 8.5% of its portfolio
as of the end of 2019. According to the latest
Securities and Exchange Commission fil-
ings, founder and CEO Jeff Bezos has an
almost 56 million-share stake—worth $105
billion at a recent $1,884 share price. His
total compensation in 2019 was $1.7 mil-
lion—a 62,226-to-1 ratio.
But a high ratio isn’t enough. Aside from
Amazon’s retail and cloud-computing domi-
nance, co-manager Rozycki says the com-
pany’s more recent forays into internet ad-
vertising are being undervalued by the
market. “Amazon has this built-out advan-
tage in its retail business and now the ability
to layer on something that produces royal-
ties on top of that retail business in the form
of advertising,” he says. “That’s extremely
profitable.” He likes royalty structures that
allow companies to collect fees with little
additional operating costs. For instance,
Hilton Worldwide Holdings(HLT), an-
other fund holding, charges 5% fees to hotel
franchisees using the Hilton name.
Nolin doesn’t just expect insider owner-
ship from his investments’ CEOs; he prac-
tices what he preaches. In the latest adden-
dum to Blue Chip’s prospectus, you’ll find he
and Rozycki each have over $1 million in-
vested in the fund, the highest investment
amount disclosable by SEC rules. “I person-
ally don’t want to say how much over a mil-
lion, but it’s much, much more than a mil-
lion,” Nolin says. “In addition to owning it
personally, I own it through my 401(k) and a
co-investment [vehicle] here at work. Tom
does the same.” As do all of the fund’s ana-
lysts. That way, the team at Aligned Inves-
tors not only seeks owner-operators, they
think like owners, too.B
Principal Blue Chip........................
Total Return
1-Yr 3-Yr 5-Yr
PBLAX 23.9% 19.9% 14.8%
Large Growth
14.3 14.7 10.7
CategoryTop 10 Holdings
Company / Ticker % of Assets
Amazon.com / AMZN 8.5%
Alphabet / GOOG 7.3
Berkshire Hathaway / BRK.B 5.6
Microsoft / MSFT 4.8
Visa/V 4.8
American Tower / AMT 4.7
Brookfield Asset
Management / BAM 4.6
Charter Communications / CHTR 4.5
Mastercard / MA 4.3
Facebook / FB 4.1
Total 53.2%
Note: Holdings as of Dec. 31. Returns through March 2; three-
and five-year returns are annualized.
Sources: Morningstar; Principal Financial GroupWhat’s in a Name?
Funds Have to Shape Up
T
he next time you buy a fund,
consider whether its name is
fiction or reality. Does it reflect
what’s in the fund? Or is it like
a Hollywood movie—beckoning you,
even if the story and title don’t match?
This isn’t just a thought experiment. It
reflects growing concern that fund names
may be misleading, confusing, or both.
The issue came up this week when the
Securities and Exchange Commission
issued a request for public comment on
potential changes to its Names Rule: the
framework for “registered investment
companies” such as mutual funds and
exchange-traded funds. The SEC wants
to make sure that fund names “do not
mislead investors,” SEC chairman Jay
Clayton said in a statement, and it’s seek-
ing comments on whether to change the
rules or guidance.
Funds are prohibited from using
“materially deceptive or misleading”
names under the Investment Company
Act of 1940. Funds with a name suggest-
ing an investment, industry, or geographic
focus also must hold at least 80% of their
assets in securities indicated by the name.
A “technology” fund, for example, must
invest almost entirely in tech stocks.
Seems straightforward. But the rules
leave gray zones; they don’t cover
strategies—a fund can add the word
“growth” without regulatory pushback
on its name. And the rules are being
tested by thematic ETFs targeting new
technologies and funds focused on envi-
ronmental, social, or governance factors,
known as ESG—two areas of concern the
SEC highlighted in its request for com-
ment. The SEC also singled out index
funds, partly because indexes themselves
aren’t covered by the rules and could be
misleading if they’re part of a fund name.
The rules could use a refresh. About
2,000 ETFs and 1,000 mutual funds
have launched since the current rules
were adopted in 2001, covering all sorts
of areas. Yet naming regulations haven’t
kept pace. Is ESG a strategy or type of
investment? Fund companies want to call
it a strategy, exempting them from asset
tests, but the SEC has pushed back, argu-
ing that funds using ESG or similar
words should abide by the 80% rule, says
Thomas Hiller, a partner with law firm
Ropes & Gray. “The SEC has pushed
funds to adopt name policies even if it’s
not clear where the rule applies,” he says.
“ESG is the big issue of the day.”
Another problem area: derivatives. A
fund using swap contracts for exposure
to the S&P 500 index, for instance, might
indicate that most of its assets are held in
Treasuries, since the notional value of the
swaps is small, says Rajib Chanda, a
partner at law firm Simpson Thacher.
That underestimates the market expo-
sure and economic impact of the swaps,
though, and it could prevent a fund from
passing the 80% asset test. “The rule has
historically elevated the nature of your
assets over the nature of your exposure,”
he says. “It’s crying out for a fix.”
Regulators have expressed some resis-
tance to names that stretch the rules. They
have denied multiple requests by ETF
sponsors to launch “Bitcoin” ETFs. But the
SEC’s Republican majority, led by Clayton,
has shown little appetite for sweeping rule
changes that would impose more burdens
on the industry. Chanda says regulators
may issue guidelines in niches such as
derivatives, tech, and ESG, rather than
rewriting the entire Names Rule. The in-
dustry would also favor a more harmoni-
ous set of rules that reduce ambiguities
and levels the playing field for everyone.
Regulators are well aware that a
catchy name can help a fund stand out in
a crowded market, and they’re likely to
keep giving fund companies some cre-
ative license. Don’t expect regulators to
draw a bright line between fiction and
reality—that's a distinction that investors
will still have to draw themselves.B
By Daren Fonda
FUNDS