Q:  What is your investment philosophy? A : Our philosophy is that a portfolio of high-quality companies with strong dividend growth is going to deliver superior risk-adjusted returns and outperform the indices on a long-term basis. We look for both capital appreciation and dividend growth. We also believe that a company focusing on dividend growth is a smarter allocator of capital that is likely to stay the course in increasing earnings over the long term. The BlackRock Equity Dividend Fund was launched on November 25, 1987, and I have served as portfolio manager since November 2001. Q:  Why do you prefer dividend-paying companies? A : We start with the premise that companies paying dividends are better at allocating capital and financing business. Such companies are better managed because they are less likely to invest in marginal businesses only to grow revenues, but they would rather stay focused on core businesses that are generating superior returns. In addition, stocks of dividend-paying companies tend to be less volatile and likely to outperform both in bull and bear markets. Q:  Would you describe your investment process? A : We start with a list of companies with market capitalization of more than $5 billion before we apply additional screens to drill down using a broad set of fundamental metrics. After running a dividend screen for a broader universe of portfolio candidates, we look at balance sheets by paying closer attention to stocks other than utilities and financials in search of companies with debt to capitalization ratio of less than 50%. With the help of our stringent debt screen we are able to eliminate companies with weaker balance sheets in order to avoid an additional layer of volatility and market risk. Once we have run these screens, we are able to narrow down the list to 500 companies for our final selection of about 80 to 120 companies in the portfolio. We try to identify sectors or industries that are facing tighter capacity utilization or supply/demand balance because they enjoy pricing power and leads to increased revenues, earnings and, ultimately, the ability to pay that out in the form of a dividend. Being benchmark agnostic, we seek to find industries with favorable characteristics, so we tend to overweight or underweight sectors that have more price competition. We like industries that are more concentrated because of their favorable pricing and revenue growth potential. In the final step of our analysis, we talk directly with management of companies and learn more about the business model as they see it. These insights allow us not only to evaluate the marketplace, but also to gain a deeper understanding of each company’s investment cycle. Q:  What is your research process? A : We primarily focus on companies with the lowest quartile cost of production, because they have the best margins throughout a market cycle and the best protection from losses in abrupt business cycle downturns. We also touch base with Wall Street analysts following the company in addition to cross-checks with the companies. And so, by questioning the companies back and forth and talking to competitors, we can get a good feel for what is going on in the industry. Our meetings with company managements guide us to the industries that have better competitive dynamics. Q:  Could you give us some historical examples to better illustrate your research process? A : In early 2003, the former chairman of Rio Tinto plc was in our offices, and during the course of the meeting he talked about the explosive demand they were seeing for raw materials going into the Chinese markets. We followed up on that, looking at producers of commodities that China was short of, like copper, for example. As a result, we invested in Western Mining, which was subsequently bought up by BHP Billiton. At that point we were beginning to take advantage of investing in raw materials that China required to drive its infrastructure and urbanization development. Even though the country’s economy has slowed down most recently, they have just announced a number of projects in subways and railways. Furthermore, China has over $3 trillion in foreign reserves to fund the domestic economy by the time exports to developed economies rebound. Another example would be companies such as agricultural and construction equipment maker Deere & Company or Caterpillar Inc. After the fall of the dollar and exchange trade, we started to see a growing demand for equipment used for mineral and ore extraction. We noticed how Caterpillar’s backlog extended out for excavators, while bulldozers and 400-ton trucks were used both in copper mines in South America and Mongolia as well as in the oil sands projects in Canada. Meanwhile, John Deere saw a strong demand for new tractors and combines as countries will have to become more of efficient producers of agricultural commodities as populations move to urban industrial jobs from rural farming occupations. Q:  What is your sell discipline? A : The factors we consider for selling a stock are adverse fundamental change at a company or an industry level. For example, we owned some natural gas producers in the portfolio at one point in the last decade when we thought there was a tighter balance for supply and demand. However, the advent of hydraulic fracturing in shale has unleashed a surplus of natural gas. That is an adverse change at the carbon industry level which transformed the supply/demand balance, so we moved our focus from North American natural gas to more oil-focused producers who are still enjoying higher prices. That is a macro change in the industry. We will also consider selling a portfolio holding if the company makes a non-core acquisition outside of its core competencies. Such a development is definitely something that always worries us. Although we meet with management to see how the acquisition is going to fit, that move is a red flag for us, especially if it takes the debt burden of the company over the 50% debt-to-book cap comfort level. If management changed dividend policies in response to a heavy capital spending program, we also see that as a red flag. Finally, we take valuation into consideration. We try to buy companies when they are cheap relative to their historic five- or ten-year valuation ranges on either price-to-equity ratio or cash flow, enterprise value operating earnings, or whatever the appropriate metric is for the industry in question. But if the bulk of Wall Street analysts are recommending the stock, that could raise concerns, especially if we do not have any incremental positive momentum. Q:  How do you build your portfolio? A : The average number of holdings in our portfolio tends to be between 80 and 120 stocks. Thus, when we get into periods of economic uncertainty we tend to diversify some of the risk away with a larger number of holdings. When buying in a company, we do not necessarily take a full position right away. We typically start off by taking a fifty to 75 basis point position and then, as the company continues to deliver on their strategy over time and we become more confident, we increase the weight of the holding in the portfolio. Over time, we seek to generate positive returns either from sector allocation or from stock selection in industries that have been able to generate gains. One of the ways to do this is making sure that we pick the better companies even in industries where we are underweight. We use the Russell 1000 Value Index as our benchmark and we tend to maintain a very low turnover in the portfolio. Q:  What kinds of risk do you perceive in the market? How do you control risk in the portfolio? A : First of all, our risk management team utilizes some of the leading analytical tools in the industry. Our local risk officer responsible for the Americas meets with one of the assigned risk analysts on a monthly basis to make sure our investments are deliberate, defined and scaled. Not only do they make us aware if we are taking any undue risk within our models, but they also make us review industry and style risk and beta. We also have quarterly meetings with our head of risk and our chief investment officer for a thorough screening of the portfolio. In addition, we stress analysis of macro factors within the team. So, if interest rates, inflation or oil prices move up, we measure how our portfolio will react under various environments so that we can see how we are positioned through the economic cycle. We tend to have a longer holding period because we have known some of the management teams for over 25 years. Having known these people over a long period of time certainly gives us confidence because we are familiar with how they have gone through their business and managed their careers. We feel that our good understanding of managements as part of our investment process sets us apart in the industry by providing us with critical insights about the industry and offering us another layer of risk control. And lastly, our desire to focus on companies that can not only pay dividends but also increase the dividend offers us probably the best defense against risk and inflation in the long term.