Q:  What is your investment philosophy? A: We’re not concerned about having a value or growth-oriented philosophy because we believe that our shareholders are interested in maximizing risk-adjusted return. Our primary motivation is being in the area of the market that is experiencing tailwinds, this is the area where investors’ assets are most productive. Each stock in the portfolio is trading at a discount to intrinsic value as we don’t like to overpay for companies, but we also focus on owning the companies with adequate to robust investor demand. So we’re looking for the companies with a factor profile that’s consistent with what the market’s paying for at the moment and we adjust that profile as the market adjusts. We create a short list with what’s working in the marketplace from a sector, industry, and investment style standpoint, and then we do an in-depth qualitative analysis. Q:  What characteristics of the market are you looking at? A: It varies. Typically, we’re looking at price-to-cash or price-to-earnings ratios to see if this is a value-oriented market or a growth-oriented market. We also try to see if the market is rewarding upward earnings revisions, earnings surprises, or relative strength. Then we evaluate the relevance of each factor on an ongoing basis. It can be anything from the number of analysts covering the stock, to market cap, valuations, beta, inherent volatility, or dividend payments. Anything can be a factor that we’ll potentially evaluate for its relevance in the current market. Q:  Do you evaluate the market sector by sector? A: We try to figure out the optimal profile in a given market. Energy has been the dominant sector over the last couple of years, for example, and that affects the profile performing well in the market. Market cap is also something that we’re constantly aware of. Then we evaluate the growth versus the value spectrum, which hasn’t been particularly relevant over the last few years. We also focus on industry performance as we want to own undervalued companies in top-performing industries. Q:  How often do you evaluate the most relevant profile for the market? A: We’re looking at that on a daily basis. Our primary focus is on what has been working in the market over the last 6 to 12 months, as we believe that this is the best way to get a sense of the nearterm future. We use the understanding of the market environment in the near past to create our best guess for the next six months. Then we look for a profile of companies that would provide the best return in that possible environment. For example, over the last six months smallcap value has been the best-performing investment style and that would compel us to start searching for intrinsically undervalued companies in the small cap segment of the market. Q:  Why do you believe that the performance over the last six months is a good indicator of the performance in the next six months? A: We’ve examined countless research studies trying to identify where the highest degree of persistence occurs. Based on our findings, we believe that the most reliable look-back period is about nine months. We feel more comfortable extrapolating a recent or an intermediate time frame than a five-year time frame. While the last six months will probably look similar to the next six months, there is a good chance that the last fiveyear period is a contrarian indicator of the future. The recent past isn’t a perfect indication of the future, but you can make your incremental course changes along the way. Q:  How does your strategy perform in sudden turnarounds, such as the one of housing stocks 9 months ago or the massive correction in technology in 2000? Wouldn’t the focus on the near-term past mislead you? A: We don’t get paid to anticipate the turns in the market even though we know that they will eventually occur. Eventually small-caps are going to underperform large-caps but until then, I’m going to maintain a fairly strong overweight. My timing isn’t good enough to anticipate when the market’s going to start rewarding large-caps over smallcaps, so I’m just going to stay with what’s working. There’s always a bull market somewhere, so we try to identify the areas of relative strength in the market place. Regarding technology, the pain for us occurred in 1999 when we had a different strategy. We were a very disciplined small-cap value investor at the time when small-cap value was the worst place to be and we never bought into the growth stock bubble. We were down 20% in 1999 when the NASDAQ was up 80% because of the growth stock mania. We stuck to our guns and it almost cost us our business. That has prompted us to develop the more nuanced strategy that we have today. We realized that life’s too short to fight the market and we’ve got to rely on something that’s working regardless of the investment climate. Currently, we’re modeling about 50 different strategies and we're evaluating their effectiveness on a trailing 6 to 12 month basis. Once we have a sense of the optimal strategies, we’ll pursue the positions that would score best relative to the individual strategies. Q:  Is your investment rationale entirely based on style rotation? A: The style rotation dynamics certainly helps in terms of alpha, but our individual stock selection is also very important. For example, right now we’re making more money in financials than the overall sector because we’re limiting ourselves to the industries in the financial sector that are performing well, like property and casualty insurers. We’ve been overweight in healthcare even though it’s been a terrible sector because of the overweight in big pharma companies. Our healthcare stocks are the pharmaceutical benefit managers and managed care, which have still been performing very well, so we’re doing better than the overall sector. That’s not necessarily the case with energy where the sectors are so monolithic that everything has been working and the alpha is more a function of being overweight in energy. Q:  Can you describe your current strategies, or the ones that you believe will be working in the next years? A: Our core value strategy focuses on low-priced cash flow and low-priced earnings. That’s the bulk of the factor profile and then it has a dash of relative strength. Basically, we're looking for companies that are outperforming but are still attractively undervalued. Currently energy scores well in this strategy. ConocoPhillips is highly rated as it is experiencing upward earnings revisions and decent relative strength over the last 12 months. It is attractively valued both on a cash flow basis and on a P/E basis. It’s trading at the low end of its historic price-to-sales ratio. Valero is another good one that’s near the top of our core value strategy. Q:  Valero historically has suffered from tight refining margins and, in my opinion, is up only because of the recent high oil prices. What would happen if oil collapses or stays around $50? By the time the earnings come in, the market may have already gone through a correction. A: I don’t think that $50 is necessarily problematic for Valero. The spread between sour and sweet is more material for the company than the overall price flow. Valero is different from some other refining companies like Sunoco, which would suffer much more from the impact of oil prices. Many of the energy companies haven’t reflected the strength of the underlying fundamentals yet. Our sense is that $50 oil is priced into Valero currently and that’s why we continue to own it. We don’t see $50 oil anywhere on the horizon and we believe that upwards earnings revisions will continue as long as the analysts' models are pricing refining companies too low for the oil revenues. Before we sell out a company like Valero, we would need to see some evidence of fundamental deterioration. We have over 200 positions in the portfolio, so we’re broadly diversified and that enhances our ability to be patient about how we trade in and out of a stock. This is another change from the strategy we had in 1999, when we only had about 50 positions. When you’re over-exposed to a particular stock that’s deteriorated, it’s a lot harder to be objective. But when you’re managing 200 stocks, you can exploit the market as opposed to react to the market. When you see an oversold stock, you can feel more comfortable about increasing your position than when you are already into it 3% or 4%. Q: Would you give us some examples of strategies that have or haven’t worked for you? A: Coming out of the bear market in 2002-2003, our sense was that the riskier strategies were outperforming. Often when coming out of a bear market, there's a lot of outperformance in micro-caps and aggressive growth stocks. We began to utilize momentum type strategies, earnings surprises, relative strength strategies, as well as market caps. We found that the sweet spot of the market was in micro-cap stocks, so we morphed into a micro-cap fund and generated returns of over 70% in 2003. Later in the same year our sense was that those strategies were beginning to deteriorate. At the same time, we were still getting good performance from the dividend-paying stocks. From a Sharpe ratio standpoint, the blue-chip, dividend- paying, large-volume strategy was working best. So we moved 180 degrees from a micro-cap growth fund to a Dow-dividend-value type of fund in early 2004. As a result, we were able to avoid the stylistic ditch that caused many of our micro-cap fund peers to lose 20% in the first half of 2004. Then the dividend-yield strategies didn’t last too long as they gave way to a core approach of strength in both valuation and growth parameters. Right now we’re a mid-cap core portfolio with a broad spectrum of market caps, value, and growth stocks. The best strategies possess a combination of value and growth characteristics as opposed to extreme value or growth. Q:  Doesn't the idea of chasing performance over the last six months contradict the value fund branding? A:We’re not necessarily chasing the stocks that worked yesterday, but we are chasing the same type of stocks that worked yesterday. We’re not just buying the best performing stock; we’re buying the stocks that are consistent with the types of stocks that have been performing well but are still undervalued. People can label us what they want, but I’d rather be called a momentum fund than a value fund. Our sense is that investors want continuous performance and you can’t do that with a “buy and hold,” low-turnover approach. Our turnover is about 100% per year as we’re constantly trying to take advantage of new developments in the market place. As a small fund with only $100 million in assets, we can move around easily without a lot of friction. Given the nature of our quantitative research, we have to ability to sift through 8,000 individual securities on a daily basis fairly effectively. We narrow it down to a shortlist of about 300 to 500 stocks and that’s where we do our qualitative research. Q:  How much of the fund is in short positions? Could you explain your portfolio construction process? A: Right now only about 4%. We employ shorting more for risk management than for money making, but in an extended bear market a much higher percentage of our portfolio could be short. By prospectus we have no limits on being short or long; we could be 100% short, 100% long, or 100% in cash. We’re looking for individual stocks with high expected return, but we’re also looking to add stocks with low correlation to the rest of our portfolio. When we add a new stock, we are looking for the diversification benefit on top of the expected return and that minimizes our annualized standard deviation. For example, if we have a lot of energy stocks, they aren’t going to score as well as healthcare or financial stocks, even if energy stocks have slightly higher expected returns. Q:  What kind of risks do you perceive and how do you mitigate them? A: We feel that we’re paid to maximize risk-adjusted return. The decision to short stocks is also focused on maximizing the risk-adjusted return and we definitely see volatility reduction as a result of our shorting strategies.