(MONEY Magazine) – A year and a half ago, few investors had heard of the Jensen fund. It did no marketing and was open to investors in only four states. But suddenly the Portland, Ore.-based fund is hot. And no wonder: While it hasn't dodged this year's slump (it's down 18.6% vs. its large-cap peers' 33.4% fall), the fund is No. 1 in its class. Excluding funds that short the market, it's the only one of more than 700 large-cap growth funds to notch a gain over the past three years. By employing a highly disciplined strategy, Jensen rose an annualized 2.4% over that period, while its peers fell 18.6%.

With investors waking up to its considerable charms, the no-load Jensen fund has had to grow up quickly. The fund, which began life in 1992 as a $10 million offering open to the firm's wealthy clients and institutions, has seen assets swell fivefold to $575 million in the past year. Much of that money came from outside its traditional client base; the fund is now registered in 50 states and available to investors in mutual fund supermarkets.

How is Jensen able to prosper while high-profile peers like the Janus fund (down 32.5% year to date) and Putnam Voyager (down 31.3%) flounder? Jensen's stringent and structured ap-proach, it turns out, is a mix of growth and value styles well suited to a volatile, sentiment-driven market. "It's the most disciplined process I'm aware of," says Morningstar analyst Langdon Healy, who covers the fund.

In the search for companies with sustainable growth, Jensen sets the bar high. A team of five managers first screens a universe of 10,000 companies to find those with a return on equity (ROE) of at least 15% for each of the past 10 years. (ROE measures how efficiently management deploys investors' capital.) The managers say such a record shows that the company has established market dominance and is evidence of strength over time.

Val Jensen started using return on equity as a stock screen when he opened his firm 13 years ago. The idea for the screen came out of William Fruhan's 1979 book Financial Strategy: Studies in Creation, Transfer and De-struction of Shareholder Value. Fruhan, a Harvard Business School professor, found that companies that surpass that high ROE hurdle for many years tend to generate gobs of free cash flow. "It isn't earnings that create value for shareholders, it's cash," says Jensen. Adds fellow fund manager Robert Zagunis: "When a company generates free cash flow, we want to see them doing something with that cash. We want to see them building up in order to make acquisitions, adding the right kind of personnel, pushing it back into the entity to create growth and so on."

Making the cut

Jensen's ROE screen leaves a pool of some 110 portfolio candidates. After looking at debt levels and valuation, the list shrinks to about 25 consistently profitable names. Average earnings-per-share growth is very healthy at 13%. The fund managers shy away from stocks sporting higher growth rates, in fact, for fear that such growth can't last. Average ROE is 20%, compared with 14% for the S&P 500. Companies making the cut range from newspaper chain Gannett to household-products maker Clorox to credit-card issuer MBNA, which sport a 10-year ROE of 24%, 32% and 24%, respectively.

Jensen will buy into an impressive history of return on equity, however, only if the price is right. A company must sell at a discount of at least 40% to Jensen's calculation of what it would be worth to a private buyer. That conservative valuation method means that for years the team couldn't buy technology stocks. And it was only this summer that they were able to buy Johnson & Johnson, which has an impressive 10-year average ROE of 27%. Over the summer, an FDA investigation involving J&J's kidney drug Eprex battered the blue-chip stock and created a rare buying opportunity for the fund. J&J is the only new stock in the fund so far this year.

Once a company finds a home in the fund, it tends to stay there--testament to the fund's ability to spot long-term winners. How does a stock get kicked out? If it misses its ROE numbers once, the company is out--for at least 10 years. Intel, which Jensen held for five years, was booted out in 2000 when it failed to meet Jensen's ROE hurdle. "Once you break our barriers, something has fundamentally happened to the business," says Zagunis.

So far this year, Jensen's managers haven't sold a single stock. Turnover in the fund is a minuscule 0.8%, compared with 120% for the fund's peers. For long-term investors, that makes Jensen an extremely tax-efficient, low-cost offering. --ILANA POLYAK