Q:  What is the history of the fund? A : The fund was founded in 1960 and the investment process we currently use to manage the fund began in 1990. The fund has a long-term record and witnessed several economic and business cycles. The moderate allocation fund competes with funds that invests in stocks and bonds. The fund typically invests approximately 65% of its assets in large cap equities and 15% to 20% in convertible securities and 15% to 20% fixed income securities. We differentiate ourselves from our peers in the moderate allocation category of funds through the use of convertible securities. We are focused on getting risk and reward in our favor. We think our investment approach and process (which has been developed and refined over 20 plus years,) of focusing on companies that are undervalued, unloved, under earning, and that have a catalyst, is unique in the marketplace. We have chosen to utilize the fixed income component as our capital and our income buffer for fund shareholders and it is meant to bring stability in the portfolio. The way we approach that is to control the credit quality through investing in high-grade bonds of corporations, U.S. government bonds and its agencies. We also maintain duration in the fixed income portfolio less than the benchmark. If we get to the point where we have a rising rate environment, everybody in fixed income will be vulnerable, but we believe we will be less vulnerable to principal damage. Q:  What is your investment philosophy and what are your core beliefs? A : Philosophically our view is that we believe stocks get mispriced and that happens for a reason; and we believe that longer term investors can take advantage of these price anomalies by identifying those companies that are underpriced and experiencing a positive change or a catalyst. If that catalyst occurs, then we have the potential to outperform the market. In terms of our core beliefs, there are two we focus on. The most important thing we do in our process is geared around always trying to keep risk/reward in our favor, seeking to protect the shareholder’s downside in the portfolio, while is also being positioned to participate in the upside. We also believe in cycles. We believe they provide opportunities and we attempt to take advantage of the opportunities they present. It can be economic and market cycles. It can be industry and company cycles. All of them present opportunities and we try to take advantage of those. Q:  What is your investment strategy and process? A : We are looking for the companies that are undervalued, unloved, that are under earning, and we can identify catalyst that can change that. We first screen for value. We want to find those companies that are attractively valued. When you think about getting risk reward in your favor, valuation is of critical importance. Buying a stock that is attractively valued goes a long way to protecting your downside. Then we look at sentiment. We measure the sell-side ratings and we want to find those companies that are under loved. If a company is lowly ranked on the sell side that means sentiment is low, expectations are low, and it also goes to protecting the downside. The final thing we do is look at returns. Our belief in cycles tells us there is a normal level of returns over time. There are times when companies are over earning and there are times when companies are under earning. We want to find the instances where the company is under earning relative to expectations and relative to normal levels. Then you want to identify catalysts. If you get the catalyst correct that is your opportunity to outperform and that is how you avoid dead money situations. Catalysts maybe fundamental in nature; the company is hitting historical trough operating margin levels, earnings expectations might be getting modestly better (or less bad) and revenues may be accelerating. There might be sector opportunities, such as consolidation. Then finally management changes, which we pay a lot of attention to. We are large cap, relative value investors. We typically invest in companies with market caps higher than $10 billion, but we will go as low as $5 billion. Financial metrics that we look at when we are screening are specific to sector coverage within the team. People screen largely to what makes the most sense in their individual sector. That might be price-to-book, enterprise-value-to-sales, price to free cash flow and price-to-earnings. Those are the valuation metrics that we gravitate towards. In terms of specific sector coverage, we are a diversified fund so we will buy companies in any sector. Similarly, we might be underweight or overweight in any sector relative to our benchmark, and/or relative to the peer group. It is a bottom-up approach. We are screening for those companies who fit our criteria and build the portfolio on a bottom-up basis. We are not afraid to be positioned in a manner in which we are underweight or overweight versus the benchmark and/or versus the peer group. Q:  Characterize your convertible bond and fixed income components of the portfolio? A : What we like about convertibles is that a convertible security is a bond and has a conversion feature. That bond is what provides us some downside protection and potential stability. In addition you get some income from that bond while you wait for the underlying equity to perform. If you get the underlying equity to perform you get to take advantage of the conversion feature and participate in the upside. On the equity side of things, we are typically large cap oriented. On the convert side of things, liquidity is also a factor. A lot of the companies in the convertible securities market are earlier in their corporate life cycle. Broadly, they tend to be smaller in market capitalization. We have a tendency to invest across the spectrum. We do not discriminate at all on the sector basis. We will buy companies in any sector if we see value there. However, it is true to say the market capitalization associated with some of the companies in the convertible universe may be smaller versus what we would buy in the equity portion of the portfolio.. In terms of fixed income; as with the rest of the portfolio, we are looking at getting risk/reward in our favor. Our fixed income allocation is meant to be a capital and an income buffer for our customers. It is meant to offer stability throughout the cycle. We have taken what we believe to be a fairly conservative approach to the portfolio, which is benchmarked versus the Barclays Government Credit Index. We invest in high-grade bonds of corporations, governments, and agencies. On the credit side of things we are not trying to do anything heroic. We have also taken what we believe to be a conservative approach in managing interest rate risk. We maintain duration lower than the benchmark and believe that should protect us in an up-rate environment, on a relative basis, versus our competition from a capital preservation point of view. Q:  Give an example of your process at work. A : A specific example is Morgan Stanley. At the time we bought our initial position it was trading at 60% of its tangible book value. To us that was an attractive value both on absolute and relative basis. To put that into perspective, at its absolute peak it traded at six times book value, now it was trading at 0.6 times tangible book value. We did the sell-side sentiment screen. It was unloved in the marketplace. Then, in terms of earnings, it was under earning relative to historical levels. Historically, the company earned in the mid- to upper-teens on a return-on-equity basis. In the new world order with higher capital requirements and some restrictions on their businesses, our view is they should be able to earn a 10% to 12% return on equity. At the time they were earning a mid single-digit return on equity. Importantly, implied expectations were for them to continue to earn a mid single-digit return on equity. We sat down with James Gorman, the CEO of Morgan Stanley, and did a lot of work. Our view was they were under earning. They were not even earning their cost of capital, which they needed to do. That was something that he, his management team, and his board, were acutely aware of. That gave us comfort that there was a certain level of awareness and urgency in the situation. Shortly thereafter, he formulated a plan to get return on equity to at least 10%. In terms of a catalyst, there was the need to get back to normal earnings but, more importantly, the catalyst was about how they would get there. We gathered an understanding that in the Morgan Stanley Smith Barney joint venture period there was a tremendous amount of investment that was taking place as they migrated multiple systems down to one system, as well as restructured the organization. The returns were depressed and our expectations, and their expectations, were that they would normalize more in line with what we saw other retail brokerages experiencing. That was returns longer term in the low to upper 20% range. The final thing was that the capital markets businesses had continued to be depressed. Even at depressed levels they were earning mid-single-digit returns, and we saw a pathway to improvement on the profitability side of things. We believed that incrementally, we had a call option in the improvement of the capital market businesses. Since then, they have completed the Morgan Stanley Smith Barney transaction and acquired the remaining stake from Citigroup. The returns on that business have started to improve and so have the returns in the capital markets segment. They have not got to the 10% return yet, but they have a pathway to get there, and the stock has responded. Q:  What are your views on catalysts? A : When we think about the catalyst we think about it happening within the next 12 months. The reality is that it does not always work like that. As long as the catalyst is still in front of us and it does not look like it is getting delayed too long, typically we will have patience. Another example is eBay Inc. In 2008, the online marketplace was hit hard because cyclically the market was getting hit and as a retailer, they were at the forefront. They also had some execution and fulfillment issues. They had some fraud issues and needed to clean up some of the vendors and people who were selling on their network. Their interface had become dated and a little bit difficult to navigate relative to some of their peers. However, eBay was attractively valued. It was selling at a double-digit free cash flow yield. It was under earning at the time because it was facing cyclical headwinds and had some execution issues as previously mentioned. It was unloved. Then we had a management change. John J. Donahoe came in as new chief executive and he acknowledged some of the issues they had in terms of the interface, as well as fulfillment and operational challenges. And, he laid out a plan for a change. The other catalyst was that cyclically things do get better over time and we had a company that had a balance sheet that was net cash positive, that was still generating a double-digit free cash flow yield and so we felt we had a lot of protection there and could be patient. On top of that, it was an incredibly unique asset. If John and his team did not fix it we thought someone else would be interested in the franchise. Another under appreciated asset, which made it even much more interesting to us, was PayPal. PayPal at the time was about 30% of revenues and since then it has grown to be 50% of revenues for the company. Q:  What is your portfolio construction process and what are your benchmarks? A : There are typically anywhere between 65 and 75 of securities in the portfolio. We are bottom up oriented but aware of our sector exposure. We apply our risk reward thought processes and quantification metrics to focus on how big of a position we might have. Within that construct, we are mindful of upside and downside opportunities and position sizes are weighted by conviction. We do not go over a 5% position at cost. It might appreciate in excess of that, but that is how we start. Our maximum ownership of foreign securities is 25%. Historically, we have ranged anywhere between 4% or 5% up to 20%. We are a value fund so on the equity side we are benchmarked against the Russell 1000 Value. We are accountable to that over time. We do, however, pay attention to the Lipper Value Index and the S&P 500 Index because we want to understand what our peers are doing. On the convertible bonds side, we pay attention to the Merrill Lynch Convertible Index. On the fixed income side, it is the Barclays Government Credit Index. Q:  How do you define and manage risk? A : When we think about risk management and discipline, the most important thing we can do is good stock selection. If we are doing a good job on the stock selection side and following our process, we have gone a long way to protecting our downside and we have given ourselves an opportunity to participate in the upside. Beyond stock selection, we manage risk broadly in the portfolio construction process. We do pay attention to how we are positioned versus our peers and versus our benchmark. That keeps us aware of where we are and why we might be behaving differently versus the market and versus our benchmark. However, we do not spend a lot of time on any specific risk metrics. We have a risk management department within the organization that we meet with on a quarterly basis to discuss the metrics they think we have biases to on an underlying basis. We do not manage to that, but it is information that is helpful to understand how we are positioned and how the portfolio is positioned. What gives us a great comfort is how we do in down markets. For instance, during the financial crisis the fund held up well. We believe that is a byproduct of our focus on getting risk/reward in our favor. Protecting the downside, and giving ourselves the opportunity to participate in the upside. The way we invest, we are very cognizant of cycles. For example, in 2004 and 2005, from a bottom-up perspective, financials to us looked rich absolutely and they looked rich relatively. They were over-earning relative to historical levels and many in the market had a fairly significant weighting. Our view was on a risk/reward basis they were no longer as interesting, so we started reducing our position versus our benchmark and versus our peer group. It started to help us in 2007, and it really helped us in that 2008 time period. Insofar as resource sectors, on the equity side of the things, we are underweight energy and materials. We have been for a while. We believe they have been materially overearning, and at the time we had reduced our exposure, they were richer absolutely and relatively. Now, from a valuation perspective, they are starting to look more interesting. What concerns us is that in those more cyclical sectors, historically, you need to see a drastic reduction in expectations. Expectations on returns are still relatively high, so we are doing a lot of work in those spaces and we would love to see something that would cause expectations to get dropped significantly. Energy is a great example. They went through a tremendous period of under investment and then starting in 2002-2004 period the level of investment began to increase dramatically. It continues to be at high levels. Historically, when you get a 10-year plus investment cycle at fairly high levels, returns turn down. We have seen returns turn down on the natural gas segment of the energy market. We have seen returns begin to roll over in crude oil, but we have not seen them come down to a level that would tell us they are washed out. Our belief right now, is that expectations are still too high and that they are effectively over-earning.