Q:  What is the investment philosophy of the fund? A : The philosophy behind the fund is strictly value-based with an orientation to companies that undergo restructuring. As we look for such companies, for example in consolidating industries, we want to see a catalyst for an immediate change within the companies. That said, we will not buy a stock, simply because it is undervalued, and hold it over the long term, hoping for a recovery in its price. Our typical investment is a stock that is out of favor, hitting new lows, or generally avoided by other investors, but with that catalyst for a turnaround in about a year or, in some cases, a little longer than that. To identify our investments, we look for stocks with a low P/E ratio, low price to cash flow, or assets that we believe are worth more than the market is paying for them. When we see a combination of all these characteristics in a company, we really get excited. A good example of a company that fits in our category is Interpublic Group of Companies, which is a recent purchase in the fund. Interpublic traded in the $60 range a few years ago, but after a period of serious earnings problems the company changed its management team. We liked the new management's plans to improve the accounting control over the different entities within the global advertising company, so we bought the stock hoping that it has the potential to double its current price. Q:  What do you define as value and where do you find it? A :We like to think outside the box rather than looking for a particular formula in order to define value. First of all, we want to find good businesses, which are not cyclical names or value companies emerging from bankruptcy. By investing in such stocks, one can achieve good investment results, but we want to stay with our companies for a long time, so we steer clear of heavily cyclical companies. We do not pursue deep value, because if you want to be successful in deep value, you need to have an experienced team of accountants and lawyers who have the capacity to measure the high risks around those companies. Since we do not see any particular industries as most appropriate for our investment approach, we maintain the portfolio well-diversified across sectors. At present, we are focusing on consumer cyclicals, material companies, and the energy sector. However, we are ready to invest in any industry as long as it is cheap and poised to grow in the longer term. One of the good ways to sustain diversification over time is to trim some of the successful holdings and invest the money in underperforming companies or out-of-favor industries. Q:  What strategy do you implement to put your investment philosophy into practice? A : Currently, I manage the fund myself and, if necessary, we may use the input of an analyst too in the future. I do a lot of reading as I try to understand what the market is valuing, by looking at the current levels of P/E ratios and price to cash flow, and then I determine our discount to those levels. At this moment, our discount is relatively low as compared to the times when value was out of favor. While we could buy many good companies back then at a discount of 50% in terms of P/E and price to cash flow, right now we can only buy stocks at a discount level of only 25%. The decline in discount levels is a reflection of the solid performance of value stocks in the past four years. If a company fits all of our metrics, the next step in our investment process is to build confidence in the company's management team by meeting them and listening to their business plans for restructuring. We do not have a black-box approach but our goal is to get a good sense of where the company is going and the progress it is making in its business. Eventually the progress will translate into a higher stock price. Q:  Could you elaborate on the buying process? How do you manage allocation in the portfolio? A : The fund is becoming big with around $4.5 billion under management as of now. Several years ago, there were 65 holdings in the portfolio, while now I own about 80 names. As a result, I currently start buying with a 1% position and I may add to it, if the stock goes down, or, in some cases, I may also increase the position should the stock price go up. What I am looking for is the potential for a gain of at least 25% to 30%, so as that price expectation narrows I will reduce buying into a company. Conversely, if the potential gain widens without any appreciable difference in the fundamentals, we may bring our position up to 1.5%. As for industry weighting, a good benchmark for the fund is a combination of the Russell 1000 Value Index and the S&P. We are aware of the weightings of these benchmarks, but we do not necessarily try to match their exposure to various industries. We put our money where there is exceptional value and, in this way, we let the chips fall where they may. For example, the portfolio is 1000 basis points underweighted in health care at this moment. We are typically underweighted in the technology sector too, just as we tend to be underweighted in overpriced sectors. On the contrary, we are currently about 800 basis points overweighted in consumer cyclicals; between 400 and 500 basis points overweighted in industrials; and double-weighted in materials. Q:  Will you comment on your sell discipline? A : The major reason to sell is our realization that we have made a mistake with our assessment of a certain company. In most cases, we have either projected better earnings from the company, or we have expected to see stronger fundamentals. Sometimes a company may fail to follow the policy reforms that it was originally planning to undertake. At least half of our sell decisions fall into these categories. In addition, we also like to sell when we believe that, regardless of a stock's performance, the restructuring is for the most part behind the company. Another reason to consider selling a stock is our commitment to the fund's value orientation. On some occasions we hit a homerun and then we are likely to trim the overpriced winner, so that we can put the money into stocks with potential for the long term. Q:  What are the core elements of your research process? A : At U.S. Trust, we have about a dozen of analysts whose research we use for the generation of our investment ideas. We also get a lot of new ideas from Wall Street research analysts. Furthermore, we use our own experience with companies in our screening for the right investments. I have been in the business for over 30 years now and I have learned to understand the dynamics of the stock market. Ideally, we are trying to find midcap companies that are likely to grow into large-cap companies when their stock prices rise. Q:  What risk controls do you have in place? A : As I mentioned earlier, we try to keep the portfolio well-diversified and, in doing so, we believe that it is a mistake to focus the risk control to a large degree to the S&P 500. We are always aware when we make a bet away from the S&P 500, and we like to make big bets away from the index. However, at one point you realize that you are throwing enough money into an industry, so you must know when to say enough in order to limit the risk in the industry. One of our objectives is to achieve a better performance on the downside. Because we do not have much cash, we are somehow mitigating risk when the market goes down. Q:  Do you have a portion of convertibles in the fund? A : Yes, we do. They are one of the ways to make the portfolio less risk diverse as we try to have ample income generation in the fund. The fund has invested above 4% of its assets in REITs and between 3% and 4% in convertibles. These investments offer shorter duration in getting your money back sooner through dividends. Moreover, they have the advantage of being taxefficient too. For five years I have owned the Baxter mandatory convertibles, which are now yielding about 6%, but when I bought them they were yielding over 7%. At the time of the purchase we liked the restructuring that Baxter's management was undertaking. We bought the convertibles when the stock was in the mid $20s, while it is now in the mid $30s. In that case we got a very attractive yield and a solid growth along with the yield. We also bought some Ford convertibles a few years ago. Although Ford has not been as successful as a stock as Baxter, the Ford convertibles had an 8% yield, when we bought them, due to fears across the market that the company might have serious liquidity issues. We decided to buy them primarily for the income generation rather than the company's growth potential. Ford has gone up modestly and it is still an attractive investment in terms of income generation. Q:  Could you provide us with an example of a good stock pick as well as one that did not quite work in your portfolio? A : One of the recent winners in the fund has been Black & Decker, which is a household name in the tools industry with far flung global operations. At the time of our purchase, the company did not have a good handle on their cost with competition from imports eating into its market share. Still, Black & Decker's management developed plans to restructure manufacturing and take cost out of the business. The stock has doubled in the past couple of years, looking still attractively priced, even though most of the restructuring is behind the company. As for our stocks with a less impressive record, I would pick Calpine, which we started buying when the stock was trading around $5, down from $50 in previous years. We bought the stock because of the management's efforts to restructure the company. The issue with Calpine turned out to be a little more cyclical that we thought but, nevertheless, the cash flow characteristics are now improving. In addition, their new joint venture with General Electric should provide growth potential to the company. We expect Calpine to break even this year and probably deliver modest earnings in 2006. The stock has not worked out yet, but we hope that it will work out in the long run. Q:  What is the turnover of the fund? A :We are definitely not traders and we like to let our winners run. Since we invest for the long term, the fund has always had a turnover ratio below 20%. In recent years, the turnover of the fund has even been around 10%. The low turnover has made the fund a very taxefficient investment product. We have not paid out capital gains distribution in the last few years, so the return of the fund is actually the return on an aftertax basis. I cannot guarantee that this feature of the fund will be the case for ever, but as long as the money is in the fund, we will try to manage it in the same way in the future.