Q: Can you describe the basic objective of your fund and how that relates to the target investor?

A: This fund is designed to be the foundation, or the central core, of an investor's long-term investment portfolio. It is appropriate for investors who have a long-term horizon and are looking for both safety and performance. The fund is highly diversified and seeks to provide an enhanced return over the benchmark S&P 500 index. By using the fund's investment flexibility between value and growth, we manage to control risk and provide a greater average return than portfolios limited to a single investment style.

Q: What is the fund's investment philosophy?

A: We manage this fund using a quantitatively structured, disciplined approach. Without a highly disciplined approach, like that provided by quantitative models, portfolio managers often over-react to daily events. Unless they have a rigid procedure that force them to weigh all of the relevant factors before making a decision, managers can make mistakes.

From our experience, we believe that a quantitative approach to investment management reduces the frequency of trading errors. We try to avoid quick buy and sell decisions based on a single headline. By using a structured quantitative approach, the full array of variables driving a stock's price comes into focus, and that tends to reduce the likelihood of rash decisions or extreme positions.

Q: Would you describe how you use these models in the investment process?

A: Every week we review about 3,000 stocks as potential buys or sells, and end up trading from 100 to 300 individual names. Monitoring such a large number of stocks would not be possible without computerized models to perform the work. The model filters current information from a variety of sources, combines it with company financial information, and highlights stocks of interest. While the logic is fairly simple, the actual process is highly complex and well beyond the ability of a single human mind.

The approach helps us avoid putting too much emphasis on short-term events or become too confident about a particular position. Because we run a very diversified portfolio with roughly 400 stocks, the impact of a single stock on the portfolio is fairly limited - either on the upside or downside. A quantitative approach also helps us focus on the big picture. Often analysts become so wrapped up in the minute details of a company's business that they fail to recognize the larger trends. By using models that simultaneously take into account internal financials, such as valuation, profitability, momentum, quality, and risk, as well as a large variety of external factors, we can develop a dispassionate prospective of the value of a stock.

Managers of growth style funds tend to focus primarily on price and earnings momentum, while managers of value style funds focus on valuations. We focus a great deal of attention on both, as well as sources of potential risk. Our models are flexible enough to adjust for changing market cyclicality and to encompass new factors that may become important. Many managers believe that visiting companies and having face-to-face meetings is the only research that counts. We do not visit companies. Instead, we do systematic research into the factors and phenomena that drive stock prices in the market.

Any information coming from management is quickly reflected in the price, but it is the deeper quantitative research that provides effective longer-term stock selection indicators, not talking to company management.

Q: How do you shift allocation among small-, mid-, and the large-cap segments?

A: When we analyze market trends with regard to capitalization, we are looking for systematic influences and not idiosyncratic influences. Market capitalization is a very important determination of portfolio performance. We divide the world into mega-, large-, mid-, small-, and micro-cap stocks. Our models are geared to take the relative performance of stocks by capitalization into account, and that factor is an important variable in the selection criterion.

We have been using relative capitalization in our models for over ten years. It appears that the market cycles by relative capitalization are not fully exploited. The relative performance goes through a cycle that may last as long as five years or more. Fund managers that focus on performance of three to five years may miss out on the benefit of these longer-term cycles. The same is true for investors looking at retirement or college savings. Having the right exposure to market capitalization can add considerably to the value of a portfolio.

From 2001 through 2003, the Oppenheimer Main Street Fund had a market cap that was only 0.80 times the market cap of the S&P 500; that is the Fund was 'smaller' than the S&P 500. That was a conscious decision based on the market environment and what our models were predicting for the next twelve months. At the beginning of 2004, the models shifted their bias from small-cap stocks to large-cap stocks. As a result, we changed our market cap to 1.25 times the market cap of the S&P 500 by the end of August, now favoring mega cap stocks.

Q: How has that helped your fund performance?

A: That decision added one-percentage point to the fund's return. That moved us to the top 9% of funds in our peer group for the three-year period, which is the Lipper Large-Cap-Core Category. For the one-year period, we were in the top 11%.

Q: Why do you believe that stock weighting is as important as stock selection?

A: From our experience, we have found that stock weighting in a portfolio is just as important as stock selection. In general, a great deal of effort is spent in stock selection but very little in stock weighting. If you look at the market in terms of market cap, almost 40% of the entire value of the market is made up of 52 mega-cap stocks. If you look at the large-cap universe by adding in the next 219 largest companies, then you add an additional 30% of the market's total value. In other words, the 271 largest companies make up 70% of the value of the market.

Since all actively managed large-cap funds essentially draw from the same basket of stocks, the difference in fund performance is often the result of the differences in weights of the individual stocks in the portfolio, not the differences in the names of the stocks in the portfolio. So the weight allocation in effect drives the performance of the funds in this universe.

Many fund managers tend to equal weight their stocks. This creates a natural bias that overweights smaller companies relative to the index. In a market where smaller companies are doing better, the equal-weighted funds tend to outperform the cap-weighted funds and these funds have a better chance to outperform the benchmark. However, in the large-cap market, the natural bias to equal weight works against these funds.

Between the years 1994 and 1998, when the large-cap market was strong, only 10% of the large-cap money managers outperformed the S&P 500 benchmark. This was because most managers allocated equal weights to their portfolios. In our opinion, managers that do not pay attention to stock weightings will face a difficult hurdle in generating competitive returns over the next several years.

Q: What are your models suggesting now?

A: Currently we believe that the stocks of larger companies with stable earnings will outperform the more speculative stocks. The risk to return ratio is definitely not in the favor of smaller companies. During the last three years, the stocks of large-cap companies have not kept up with the valuations in the market; and, as a result, they currently have a much better risk to return ratio.

Q: What is your sell discipline?

A: In general, we stick to our models. We don't take large positions in any one name, so when a stock does not perform consistent with our expectations, the risk to the portfolio is not that great. If a particular stock starts to deteriorate, it will be reflected in the scores generated by our models and we will start selling the stock. Alternatively, if the stock performs well for us, then the relative weight for that stock will increase. If the weights get higher than the target weights, then we would again sell the stock.

Q: What factors are the most important in your portfolio management process?

A: Our portfolio management process consists of three important elements. The first step is the allocation by relative market cap, where we decide whether to over-allocate or under-allocate either large-cap or small-cap stocks.

The second step is the specific stock selection process, where we use different models with optimized variables for each universe to select from the mega-to-micro cap stocks. But no matter how much we like or dislike a particular stock, we have to stay within the allocation limitations.

The third step is trading and execution. Some large portfolios are so concentrated that trading can have a significant market impact even in the large-cap world. This is called market impact and it can add significantly to the cost of buying and selling a stock. In our portfolio, the turnover rate averages from 70% to 80% and the portfolio is not concentrated on a few names. As a result, our cost can be much lower than a typical fund because our positions are smaller and the pace of adjustment is more gradual.

Q: How do you identify and respond to the market signals?

A: At the end of 2002, the quality of credit spreads between high yield and low yield debt was very high. That was a signal that the small-cap stocks were likely to outperform, and that turned out to be correct. Between October 2002 and the first half of 2003, small caps outperformed all other categories. Right now we are looking at how the higher risk assets are priced and how they are likely to perform in coming months. And we are also looking closely at valuations.

In contrast to early 1999, when large caps were extremely expensive relative to small-cap stocks, the large caps are currently very attractively priced. Historically, we have identified statistical patterns in the relative movements of large- and small-cap stock valuations, interest rate spreads, short-term momentum, and long-term reversals. We are currently trying to identify which market cap category is likely to outperform or underperform.

Q: What is your risk control process?

A: As we indicated, our allocation process limits how much we can overweight our best ideas or underweight stocks that we like least. We do not use an explicit sector-based allocation; however, an implicit allocation results from the portfolio construction process. In general, our sector allocation does not differ from the S&P 500 by more than 500 basis points.

We do have a separate risk management group independent of the portfolio managers. Every month they provide us with an analysis of risk measures and performance drivers base on an independent risk model of the portfolio. That gives the portfolio manager another perspective so he can assure himself that he is not taking unintended risks.

The group also monitors the portfolio to make sure that our investment strategies are consistent with stated objectives of the fund and not taking extreme positions. Over the long term, risk management is very important if the fund is going to fulfill its objective.

If you underperform the benchmark by a substantial amount in a given year, it may take years to make it up, but the fund's investors may never be able to achieve their retirement goals.