Q:  How would you describe your investment philosophy? A: The starting point for everything I do is the search for value added over and above what investors would get in an index fund. There has to be a good reason for investors to choose an actively managed fund, particularly with the overwhelming statistical evidence showing underperformance for the majority of managed funds. Since this is a large-cap growth fund, the process is tailored to that particular space: the most visible and deeply researched part of the market. I don’t believe one can build a sustainable advantage in large caps through traditional research and implementation methodologies. There’s little or no information edge to be had. Success depends largely on the interpretation of the information and decision-making processes. That belief drives the entire process, including the research and the portfolio construction. I do believe that earnings are the essence of the stock market and that earnings expectations are the single most important factor that drives stock prices. Therefore, I look for companies with improving earnings dynamics and avoid companies that don’t execute above expectations. I also believe that superior management is essential in delivering consistent earnings, so I look for management that proactively drives the growth process rather than just riding a wave of positive industry dynamics. For example, the managements of Toyota or Apple are always looking over the hill to see what is next. They are willing to reinvent their companies in order to stay ahead. Q:  How do you translate that philosophy into an investment process? A: I believe that one of our competitive advantages is recognizing that there is an inevitable bell curve distribution of skills in every endeavor, including investing. This means that the majority of the stock analysts are average and a good percentage of them are going to be dangerous. One of the problems with many funds is their large staff of analysts. This creates an inevitable imperative to use their information and conclusions to justify the expense of having them on staff. Yet most of their output is of little value. Only in Lake Wobegon are all analysts above average. At the same time, group decisions are among the worst decisions made. Groups tend to reduce the variance of opinion. Members of groups enjoy greater credibility among their peers when they provide information that’s consistent with their peers. But when you are in the investment business, variance of opinion is absolutely imperative. The bottom line is that more minds in the room end up being a handicap to, rather than an enhancement of performance. So instead of using this mid-20th century factory-like staffing model, I utilize the information gathering power of the Internet. There are so many resources that I can use to assemble a ‘virtual staff’ of analysts. That approach enables me to filter the information effectively and avoid pernicious circular analytical group-think. That is one of the central differences between this fund and our peers. Since there are no undiscovered gems in the large-cap space, our process is oriented not towards finding the gem, but rather towards picking the right time to be in and out of that gem. In addition to various psychological factors, the primary statistical metrics in our process are earnings-oriented and we make decisions with an eye towards valuation. We look to find the highest sustainable earnings growth at the lowest possible multiple. I’ll rarely buy a stock with a PEG ratio of above 1.75 because these stocks tend to incorporate optimistic projections that are rarely sustained. By the same token, I have found low PE investing, while sound in many ways, is subject to value traps. I have found that the sweet spot of the market is the stocks with PEG ratios in the range between 1.25 and 1.75. That universe consists of only about 250 large companies and I follow those companies carefully. The goal is to pick the best of breed and best in show. Q:  Could you give us some examples of the types of companies you look for? A: I look for companies with the size, the management skill, the financial health, and the product that set them apart from their competitors. I refer to these as ‘best of breed.’ Examples of such companies would be McDonald’s, Johnson and Johnson, Caterpillar, or UnitedHealth. The companies that stand out even in this best of breed screen I refer to as “best in show” and are overweighted. Instead of having a 2% to 3% weighting, they would have a 4% to 5% weighting. In addition, I also look for companies that are carnivores in the economic jungle - true ’killer competitors’. These are companies that genuinely think outside the box. They have managements with the courage to introduce new concepts and get substantially different results. Three classic examples of such companies are Apple, Toyota, and Goldman Sachs - companies that are on the very top of the food chain. Q:  Would you highlight your portfolio construction process? A: I run a compact portfolio with about 35 stocks. For risk control purposes none of the holdings is larger than 5%. Positions tend to be in the range between 2.5% and 5% depending upon their category and my degree of confidence. I have trouble squaring the conventional wisdom of long term buy and hold when the reality is that nobody knows how a company is going to execute over the next three to five years. Apple is a great example. If you remember the pre-iPod era - just four years ago - Apple was rightly considered a small niche player that regularly disappointed. Now it’s a media juggernaught. Three or four years ago, Dell was a colossus; now it’s in trouble. The world is changing fast and with globalization, there are more ingredients coming into the mix which make corporate prospects even less predictable. So when I buy a stock today, I can’t say with any intellectual honesty whether I will own it for 7 years or 7 weeks - it depends on the environment. Thus, an important part of our strategy is to ‘trade around’ our positions. There is often high volatility in even large and well known companies that can create significant trading opportunities. Though the investment world is committed to the ‘buy and hold’ approach and considers low turnover to be a virtue, you’d be surprised how often low turnover leads to mediocrity. For example, if you owned Google or Apple at the beginning of 2006 and didn’t make one move during that year, you’d have lagged the market while owning two great stocks. That’s not intelligent money management, in my book. We owned both Google and Apple, traded their volatility, and achieved returns well above their yearly statistical gain. So, yes, I have a trader mentality. But because I’m managing a small fund and because I’m working with the largest and the most liquid stocks, I have the ability to move in and out speedily and with very low cost. Overall, I believe that the value added of a good large cap growth manager comes from being on the lookout for the periods of euphoria, panic, or events that drive the market or a stock. If you know the fundamentals of a company and have followed it long and deeply enough to know how it trades, you can easily find times when the deck is really stacked in your favor. That’s when you take action. So we generate a higher turnover rate than others but in doing so we create value. You only have to look at how the average low turnover large cap growth fund did in 2006 to see the extra value that can be created by being open to proactive management. If you don’t do this, at least within the large cap growth space, you might as well buy an ETF or an index fund. I believe that my approach also reduces risk. I am less likely to ride an individual holding, a sector, or the market down. By constantly replenishing the portfolio with new ideas, I am able to move out stocks that have already realized 60% or 70% of their gain. With the high turnover, I am filtering in new names that haven’t moved as much and I am able to keep the risk level of the portfolio down. There is a fine line between stubbornness and conviction. Money managers shouldn’t complain about the wind but should just adjust the sail. We always have to guard against that over-confidence and give greater weight to our flight instinct. Q:  When would a company like Apple in the pre-iPod era appear on your radar? A: It wouldn’t have - before the iPod. Pre-iPod Apple was just a marginal computer company. But I remember how difficult it was to download and play music on MP3 players in the preiPod era. Then the iPod came, and just seeing the ease with which my kids adopted it, I knew that it was going to be huge. Apple wasn’t the first MP3 player, but it was the first userfriendly MP3 interface for the masses. Likewise, Henry Ford didn’t have the first car, but his Model T was the first broadly usable car. More importantly, Apple didn’t rest on its laurels and that’s where innovative management comes in. They came out with a new iPod, and then another version of the iPod and then another, cementing that relationship and staying ahead of competition. Q:  What are your views on risk control? A: I control risk in two ways. The first one is not letting any position get out of hand because I don’t think that the returns justify positions larger than 5%. That means that any single mistake is not going to affect a large part of the portfolio. But the greater risk control is my willingness to sell at the first whiff of trouble and not to give anyone the benefit of the doubt. If events show that I was wrong, I can always buy back in. I don’t let my ego get involved. My trading costs are low enough to enable me to avoid the stress and the downside of a mistake. When the cost is virtually nothing, it removes the necessity to stick with something when in doubt. Q:  How do you try to protect your shareholders against companies like Enron and WorldCom? A: Fraudulent practices are something that I cannot control. What I can control is my reaction. I don’t waste time worrying about corporate governance, because that isn’t going to make any difference. But when something is rumored or an event occurs, I will shoot first and ask questions later. To me this is the only way to reduce risk because when a company is trying to hide stuff, it always can, at least for a while. But when something blows up, my willingness and ability to move very fast helps my shareholders.