Q:  Can you give us an overview of the company and the fund? A : The Select Equity Fund was launched just over a year ago in January and currently manages $38 million. The fund primarily invests in mid- to large-cap companies with stable earnings, free cash flow and strong balance sheets but these companies are trading at attractive values relative to their long term earnings potential. Atlanta Capital is managed by three seasoned professionals with a long history of working together and selecting companies based on fundamental analysis with a value investment discipline. For over 40 years Atlanta Capital has been managing high quality stock and bond portfolios for individual and institutional investors and currently manages $15.8 billion of assets with $7.7 billion in mutual funds. Eaton Vance owns the majority of the company. Q:  What is your investment philosophy? A : We are trying to identify great businesses run by honest and capable management teams and try to buy these businesses at below, fair value. We call that high quality investing. We want these great businesses to generate stable and growing earnings that compound over time, and to do it with very low volatility because what’s important is the variability around the average. If you have very volatile earnings, it affects your total return when you start to compound that over time. The way we define quality is with the consistency in earnings over time. We have done some academic research that shows that you get slightly better returns with a lot less risk with this type of approach. Over the years I have found that it is not what you make, it is what you get to keep that counts. When you lose money you have to grow exponentially to get it back. There is a huge advantage to preservation of capital. Q:  What is your investment strategy and process? A : We are looking for companies with stable earnings that generate free cash flow. All the companies that we invest in are self-funded. In this recent downturn, when the capital markets actually did shut down, our companies were able to continue to grow and take advantage of the dislocations in the markets to become better positioned within their business. They were doing things they normally don’t do, such as make acquisitions, because at the time prices came down so they were much more attractive. The private equity guys that had been bidding up a lot of assets out there obviously had all kinds of other issues to deal with such as trying to fix what they had over paid for and over leveraged. You make money in bear markets; you just don’t know it at the time. We are trying to identify companies with some kind of competitive advantage that is sustainable over time. If you look at the portfolio of all the holdings we have, you will find high return on invested capital, high return to equity, and good balance sheets. There are probably about 300-350 companies that we truly believe are great businesses. That small and stable universe allows us to get to know them over time. We visit all the companies we invest in. We think that is terribly important. We like to understand the culture of a firm. What separates it from its competitors? At the end of the day, that is truly the only thing that is different between firms. From there we put together a broadly diversified portfolio. We currently have about 28 holdings. The thought process is that by definition, there aren’t that many high quality companies so the fewer the better. To be more concentrated is beneficial. We look at it as a form of risk control. We have a three-person team and do not have any analysts so we have to do the work ourselves. Being more concentrated allows us to do the work more realistically and honestly. Q:  What is your research process? A : For this particular fund we have a market cap of about $3 billion and above. We use the S&P Quality rankings and generally concentrate on the top third of that universe. It is a pretty good proxy for quality and we’ve done a lot of academic research that shows that you get slightly better returns from a high-quality universe with a lot less risk. We spend a long time talking to companies that we know we are not interested in or are not good fits because we are trying to get a feel for the industry, or competitors of companies we own. One of the standard questions we always ask is what companies do they admire, whether they are suppliers or competitors. If you ask that question enough and you start to hear the same company over and over again then it is probably worth spending some time researching that company. That is a great way for us to get new ideas. To a certain extent we are also open to look around and see what companys are popular with some of our peers. There are some good managers out there and we’ll look to see what they own and if we see the same company in different portfolios over and over again then we will probably should spend some time researching the company. One of the advantages that we have over most of the other large cap managers is the fact we manage small- and mid-cap funds as well. As these companies grow and fall into our universe we are already familiar with the business model and earnings driver. If you look at our benchmark, Russell 1000 index, the median company market capitalization is about $6 billion. Half the universe is really small cap companies where we have a true competitive advantage. Most large cap managers tend to be more intested in the larger capitalization companies because they are bigger weights in the index. Most large cap managers are more intested in relative performance rather than absolute returns. Initially we look at some statistics and then we sit down and read the regulatory filings. There is lot of information available in these quarterly and annual filings that investors can take advantage of if they are prepared to spend time to read. Once we get through the initial research, if we think it is truly a business we would be interested in, at that point we set up a call with management. We go through the story, let them share the details of their business and then they answer any questions we may have. At that point, one of the three of us visits with the company’s management. The structure is a bit unusual but generally speaking the smaller the team, the better the performance. It always puzzled me why in a traditional structure where you have a group of portfolio managers and a team of analysts, why you would put somebody between the person who is making the decision and the actual investment? We have a three-person team and we don’t have analysts. We all have to do the work independently. Then we get together and we discuss the issues. Generally it is very easy to identify whether it is a good business or not. After that visit we come back and start to do work on valuation, which is a little perverse. A value manager starts with price first and then understanding the business. We are trying to identify a great business first and foremost and then we come back and decide what we’re willing to pay for it. Generally, most of the companies we are interested in are trading at or above what we believe is fair value. However, we are trying to buy good businesses that are trading at a discount or below fair value. What we have to do is do the research, understand the business, and then be patient. I think we have done a good job of being patient and waiting for the market to give us an opportunity to buy these businesses on sale. They are good compounders in their own right but then if you can buy them below fair value, you increase your total return. We have a small universe that is made up of a stable list of companies and that allows us to get to know the companies and visit the companies. There are some companies that have been on the list for years, but we just haven’t yet seen the valuation where we want it. It takes all three of us to get a name in, out, or up and down in weight. The only way a structure like that works is if you have got a lot of respect for the people you work with. The difference between what we do and what a lot of other investors do is that my clients hire me to make them money. They don’t hire me to be right. I think a lot of investors confuse that. They want to prove how smart they are. They want to take high profile positions in companies. They want to influence management. Maybe they’re right sometimes, but oftentimes they are wrong. I think your ego can get in the way. We own Affiliate Managers Group. It is a company I briefly looked at and shrugged off because there was a company called United Asset Management and they had gone out and made a lot of acquisitions of other asset managers and they rolled them altogether and it was a terrible disaster. I did not pay a lot of attention to AMG until the management team from AMG came knocking on our door. This was prior to us looking for a partner and they introduced themselves and shared their business model, which is very unique. As we went through our own process of selling our firm, the person that knew us better than anyone else that bid for our company was AMG. They had shown up three years prior, they understood our philosophy, and our process. They knew the senior management and had an opportunity to meet some of the younger people in our firm. As we went through the process of looking for a partner ourselves, even though we knew that Affiliate Mangers were not going to be the high bidder, and they turned out not to be, because they are very disciplined, we allowed them to stay in the process to the very end. The people that choose to sell to them are looking for a true partner. They are trying to grow their business as opposed to getting the highest bid. That is why they have been so successful over the years. I think it is the structure that they have. When we originally bought AMG it was less than $1 billion in market cap. The company graduated through our small-cap and our mid-cap and now it’s in our large cap portfolio and the market cap is over $8 billion. It has been a great investment for us over the years. The asset management business is a good business. It has very high margins, good cash flow, and very little capital is needed. We are a good example because we don’t have a mutual fund. We were strictly in the benefits business. We needed an infrastructure and a sales force to get into that business. You can choose to do it on your own or you can partner with somebody like AMG who already has a structure in place, already has the legal entities in place, and has a global sales force to help sell mutual funds and launch new funds. That would be a perfect example of where they would add the value. Somebody who is a really good investor generally runs the strategies but then to take it to the next level, various corporate, operational and administrative functions can become distractions. If I can find somebody who can help me with my compliance issues, who can help me with growing my sales force, things that are non-investment related, that’s where AMG will step in and say that they will handle that. It also provides a transition from one generation to the next within a firm. If you look at their deals, what happens is the senior partners get some liquidity. That liquidity then gets recycled to the next generation. It is extremely expensive and that second generation doesn’t often have a lot of money and they can’t afford to take out the senior partners. The only way they can do it is to leverage up and take on a lot of risk. If the market goes down all of sudden, the second generation is in a really bad position. They’re leveraged up, they’re worried about their own financials, and they’re trying to manage a portfolio on top it. It’s not a very good combination. AMG get to relieve a lot of that. Another example of a company that like is LKQ Corp, the largest owner of junkyards in the U.S. The way their business works is, as an example, when my wife dinged up her Suburban going through the drive-thru at Starbucks we had to get it fixed, because it took out the rear quarter panel. The insurance adjuster came out, writes out the claim and he has a couple of choices. He can use the original manufacturer, which is General Motors, to supply that part or he could get a generic part made by somebody other than General Motors. Or he could use a used part off another Suburban that may have been wrecked and had the front-end damaged but the rear quarter panel is just fine. By using one of those alternative parts, the insurance company saves anywhere from 20% to 50%. There is a huge incentive for them to write that claim and to have an alternative part used. The insurance company pays for the auto body shop that is repairing that item. They already know what they are going to get paid so for them their incentive is to get you in and out as quickly as possible. They make money by turning the bay, by keeping that volume coming through their shop. That is where LKQ comes in. They are not only the largest junkyard company in the U.S. but they are also the largest owner of a generic parts company. All of a sudden we have the largest player in both those two segments. If you are running an auto body shop you can make several phone calls to junkyards in your town or you can make one phone call to the largest player with the biggest network. There is a network effect here. More recently we made an acquisition of a similar company in the U.K. They have a very similar infrastructure and network and they are then going to use that as a platform to go into the rest of Europe. LKQ is ten times larger than their next competitor. They dominate a niche that is still undiscovered. There is really no competition when it comes to them, at least on the junkyard side. Most junk yards are still owned and operated by families so they have the ability to make acquisitions from time to time and scale up. It is an extremely stable business whether the economy is good or bad. People don’t choose to be in accidents, they just happen. As the population grows, as density grows, you have more accidents. As the price of automobiles go up it becomes more advantageous to fix it, at least the body, maybe not the mechanical side, which is a slightly different business, but on the body side it’s just an incredibly stable business. Q:  What is your portfolio construction process? A : We are interested in companies with a market cap of $3 billion or more. The Russell 1000 index is our benchmark although we are pretty agnostic. We are more interested in absolute return than in relative performance. The benchmark is less of an issue for us than other people. We have a range of between 25 and 40 holdings. It is currently 28 and generally equally weighted. We have some that are higher and some lower, based on conviction. One of the observations that we’re conscious of, but it’s an unfortunate reality, is that if you look at most managers, they get better performance from their lower weights in their portfolio and less return from their higher weights in their portfolio. They do it based on conviction.If they have a lot of conviction then generally the market does too and prices that security appropriately. I think people think if you have fewer names, you have more risk. That is not necessarily the case. Even more so with the way we manage money – starting with high quality companies really mitigates the downside for us versus most other managers. Our turnover last year was about 12% and we are long-term investors. We do have a max of 10% position size in any one holding. We try to stay diversified across sectors. We are a bottom-up manager. Our clients hire us to allocate capital. We in turn look for management teams that have demonstrated an ability to allocate capital correctly. It is less of an issue for us. There have been a handful of occasions where it’s become very obvious, like in 1999 during the tech bubble and a couple of years ago with housing, that was pretty easy to identify and we have avoided areas of the market that were exposed to that. It is really a bottom-up approach. Q:  What risk control measures do you take? A : We define risk as permanent loss of capital, negative returns, much less than relative, because you can’t spend relative performance. We do measure risk and are cognizant of it right at the beginning when we pick stocks; unlike a lot of other managers for who risk control starts at the end of the process where they put together a portfolio and run a lot of analytics to see where they have made their bets and adjust the portfolio accordingly. Our risk control starts at the beginning of the process by concentrating exclusively on high quality companies with stable earnings and good balance sheets. The result of that is we provide downside protection. We also have the lowest beta of any large cap manager out there because at the end of the day it’s not what you make but what you get to keep that counts. Our clients don’t like surprises and we don’t like them either so it’s really about managing downside protection to us. Our risk is not to the downside; it’s to the upside. In a bear market we’re going to outperform at least on a relative basis and what that allows us to do is to take some of that relative performance generated during the bear market and actually put it to work in the market when everything is on sale. The highest turnover we have ever had was in the first quarter of 2009. Everything we had always wanted to own was on sale. Great businesses, great balance sheets and these businesses were not going to go out of business. They were going from making money to making less. They were not going from making money to losing money. We were able to position the portfolio and buy great businesses and that paid off over the last five years. The market is up a lot and we were able to participate and actually out perform even in a very strong market.That is because of the risk controls that we put in place at the beginning of the process by focusing exclusively on high quality.