Q:  Would you provide an overview of the company? A : Since 1999, the Jacob Funds have been offering access to a wide range of products from funds focusing on specific sectors to broader funds that specialize in younger, emerging companies, or funds that invest in larger, more established firms that have proven to be leaders in their industries. Our California-based investment firm manages approximately $60 million in three funds, namely the Jacob Internet Fund, Jacob Small Cap Fund, and Jacob Wisdom Fund. I am the Chief Portfolio Manager of the Jacob Wisdom Fund, and Ryan Jacob is the Chief Portfolio Manager of the Jacob Internet Fund and the Jacob Small Cap Growth Fund. The investment objective of the fund is to maximize total investment return, consisting of a combination of income and capital appreciation. Q:  What is your investment philosophy? A : Our goal is to find investment opportunities in companies with enduring franchise values and strong potential for profitable growth. We believe that the ability to generate high returns on capital over a long period of time is the most important component of intrinsic value. We always feel that it is better to buy great businesses at reasonable prices than buy mediocre businesses at great prices. We like to invest in companies that have growth, but we do not like to pay out too much for it. Q:  How do you transform this philosophy into an investment strategy? A : The fund invests primarily in equity securities of large U. S. companies, but may also invest in small- or medium-sized companies. Under extraordinary circumstances, it may also invest up to 35% of net assets in fixed income or debt securities to seek income. At times we may gain exposure to foreign markets through the global operations of U.S. companies, or through direct investment in foreign companies. The fund seeks companies at reasonable prices with sustainable competitive advantages that may allow them to generate above-average returns on capital over long periods of time. Q:  How do you execute your research process? A : We follow a three-step process to identify and monitor the fund's investments. The first step in our investment process is to narrow down the universe of possibilities and to focus on what we feel are the most attractive opportunities. We do this research by scouring the Web, reading analyst reports, running quantitative screens, attending conferences, and speaking to executives. Once we find an intriguing investment idea, we then deploy a thorough qualitative and quantitative review process to determine if the opportunity is as attractive as it appears and can be had at a fair price. Ideally, we are looking for companies that play in large markets in which there are significant barriers to entry; enjoy a strong competitive position with growing market share, and boast capable management teams with proven track records. We want the companies to have unique assets such as proprietary technologies or with the possibility that positive near-term catalysts could drive the value of investment higher. If everything looks good qualitatively, we will turn our focus to valuation. We evaluate many different quantitative criteria including cash flows, margins and balance sheet itemsto determine what a company is likely to generate in sales and profits for the coming years. Then we use several different metrics and calculate a fair valuation based on those estimates. Once we have added an investment to one of our portfolios, we continue to monitor the position closely, making sure that our original analysis remains valid. We will often rebalance or potentially exit a position if the risk/reward ratio for the investment changes materially. Additionally, we conduct detailed portfolio reviews on a regular basis. Q:  Would you use a few examples to highlight your research process? A : One of our top holdings is The Coca-Cola Company, the owner and marketer of nonalcoholic beverage brands. The Coca-Cola Company generates huge returns on capital and pays out a significant amount of the cash flow in dividends. It has got a higher yield than the ten-year Treasury, and importantly, the amount of capital it plows back into the business generates high future returns. The soft drink business has moderate growth and generates very high returns on the margin of capital the company deploys, which is close to 20% as well as throwing off a substantial dividend. In terms of price-to-earnings, the stock is not expensive and it also has nice positions in emerging markets. In fact, they have been able to duplicate its profitability formula everywhere they’ve launched operations. While the business has some minor competition in local markets, it is mostly oligarchic with only one other true international competitor, Pepsi. The primary reason why we have Coca-Cola in our portfolio is because it is a very stable company with a potential for significant above-market returns. Another example of a holding we own is The Proctor & Gamble Company, which is one of our top three holdings in the portfolio. This provider of branded consumer packaged goods, which has been around for 175 years, also has very stable businesses and operates at high margins. We like owning it because the company is growing strongly in emerging markets, enjoys a strong competitive position around the world, has a strong balance sheet, and the stock is selling at approximately a market multiple. We also have some fairly large positions in some issues that are not so well known. For instance, we own three positions in mortgage REITs. The major ones we own in this category are the Annaly Capital Management and Anworth Mortgage Asset Corp. Both companies leverage themselves to invest in agency mortgage-backed securities and these companies are generating returns on book of somewhere in the teens. They have over 95% of their assets as pools of mortgages that are guaranteed by the government agencies. The asset side of the balance sheet is transparent, and therefore the value is easily determined. They also trade at book value and the return on equity is in the mid-teens. MFA Financial Inc. is another mortgage REIT we own. MFA is slightly different in the sense that only about 85% of its assets are mortgage-backed securities guaranteed by the agencies and the remaning 15% are other mortgage-backed securities that are not guaranteed. Admittedly, it has somewhat more risk but also offers more reward potential. Q:  Do you have established targets for the fund? A : We have not established any specific targets but we have targets for individual companies as to what we think their return on capital or the profit margin should be relative to the business they are in and the competitive position within that business. Still, in terms of the portfolio, as a whole, we do not have a target return. Essentially, we are trying to beat our benchmark, which is the S&P 500 Index. Q:  How do you construct the portfolio? A : Presently, there are 39 names in the fund. We generally do not buy anything more than 5% of the portfolio and, at this stage, have only two positions that are above 5%. We diversify to some extent but try to avoidoverdiversification. We like to hold somewhere between 30 and 50 names in the portfolio because we think that 30 names can provide proper diversification. Q:  When would you sell a stock? A : We sell a stock primarily in three ways. First, when the company’s fundamentals have changed or our assumptions as to future returns on capital or competitive position change. Second, we may sell a stock if we find an alternative is better. For instance, if we are fully invested and have a particular issue that we find should be in the portfolio, then we will sell something else to make room for it. The third criterion for the sale of a stock is just the valuation. If we find that the price of the stock is close to what we think the intrinsic value might be, we will probably begin to scale it back. If the price continues to move up to the point where we feel it is overvalued, then we will be moving out of the stock. Q:  What do you consider as sources of risk and how do you control risk in the portfolio? A : The sources of risk are manifold with the macro-type risks certainly being among them. There are two ways in which this risk can be contained. First, we move the portfolio into the most conservative investments. And then, we carry more cash (on the order of maybe 15% to 25%) which will meaningfully – but not totally – protect the downside. In addition to maintaining a diversified portfolio, we like to be close to fully invested and we will very rarely be carrying high levels of cash. Lastly, we guard against business risk by analyzing a firm’s stability in terms of its balance sheet and cash flows..