Q:  What are the core beliefs that guide your investment philosophy? A : We are long-term patient investors looking for value in the small- and mid-cap market segments. We generally seek out stocks when they are out of favor and will hold them patiently as the market slowly recognizes their value. However, we limit our purchases to companies where we can understand their business models and forecast their outlook into the distant future. Our disciplined approach has helped us avoid the hot stocks of the month or the year while retaining confidence in our holdings even when they are unpopular. For over 25 years, independence has been a hallmark of our investment philosophy. Q:  How would you describe your investment strategy? A : The fund invests in undervalued companies that show strong potential for growth. We want to ensure that companies are financially strong but statistically cheap. When it comes to investing, we take a long-term view — generally five years. We seek businesses with durable competitive advantages. To this end, we identify companies by the free cash flow the business generates and also by the returns on investment or returns on capital. Other financial metrics that we delve into are operating margins or earnings before interest, taxes, depreciation and amortization (EBITDA). We will initiate a position when there is a significant margin of safety. We seek to buy companies trading at a 40% discount to the private market value (PMV) we have calculated or 13 times next year’s earnings. There are really three methodologies that we use to derive our PMV. These are discounted cash flow analysis, a change of control calculation and a full-and-fair valuation. We are generally not interested in companies that are highly leveraged. We want to be confident a company’s balance sheet can withstand any type of economic disruption so we examine whether the net debt to EBITDA is at a sustainable level. We also look at the interest coverage ratio and typically seek an interest coverage ratio of at least three. Finally, we take into consideration a debt rating for each company. We do not rely on external debt rating agencies but focus instead on a proprietary rating system developed by Charlie Bobrinskoy, our Director of Research. Q:  What is your research process? A : Our research process begins with extensive reading of publications in search of potential ideas. Additionally, we get new ideas by reading research reports from brokerage firms and we rely on the expertise of our senior analysts. Once an idea is generated, our initial work seeks to confirm that the underlying value of the enterprise is not reflected in the stock price. So we start with the valuation work to create a PMV. Next, each analyst who is in charge of the industry writes up a new idea in a thoroughly independent research report. These reports contain a slew of statistical data as well as an investment thesis, a formal recommendation, a description of the company’s business units, an analysis of its niche versus competitors, the headwinds facing it and an analysis of the management team. These research reports become the anchor for our weekly discussions in the investment committee and portfolio management meetings. Typically we raise new questions in these forums that the analyst must answer through more research. Sometimes we may come back at the next meeting with more questions, and we often have special meetings just to delve into one idea in detail. We also talk to competitors, customers, board members and management to obtain an independent view of the company. We think meeting management is important to building trusted relationships with them. Every quarter we assess the management teams to see how they are executing their plan and whether they still have confidence in their plan. Our belief is that if we do not talk to managers on a consistent basis it is hard to evaluate whether they are gaining or losing confidence. This practice also enables us to determine which management teams do care about their shareholders. Q:  Would you define your sell discipline? A : We sell stocks when we believe they are fully valued or when our reasons for purchase no longer apply. Also, we sell when stocks trade at 20 times next year’s earnings estimates. We may also sell a stock when there is a major change in the competitive landscape, a substantial shift in the company’s fundamentals or a loss of faith in management’s abilities. Among other reasons for trimming a position are when it gets over 5% of the portfolio, or if a stock moves to another market capitalization range. We sometimes sell a position if we are fully invested and find a better bargain elsewhere. Q:  Could you share some examples to illustrate the kind of companies you like? A : One of the model companies that we have owned for more than ten years is The J.M. Smucker Company. It is a consumer products company that sells Smucker's jams, Jif peanut butter and Folgers coffee. J.M. Smucker has a best-in-class brand not only in their jellies business but also preserves and other similar products. The company also has strong cash flows and has maintained a very strong balance sheet since we invested in it. We first bought it in 2000 for an initial purchase price of $19.51 per share and currently the stock is at $71.81. Another company that we have owned continuously for close to twenty years is T. Rowe Price Group, Inc., which is held in our Ariel Appreciation Fund. It is a leading asset management firm known directly for its moderate, long-term investment style. We initially purchased the stock in 1999 for $15.23 per share, and currently the stock is at $64.50. T. Rowe Price has an exceptional management culture. In addition to delivering high-quality products and services to the consumer, the company has built a great brand reputation in the 401(k) marketplace. Most importantly, it is a company that fits squarely in our circle of competence. There is something similar between J.M. Smucker and T. Rowe Price. Both companies possess characteristics that we largely appreciate: they have strong brands in sectors that we understand well; their customers always come first; and there is a consistent supply of quality products. Another relevant example would be DeVry Inc., a holding we have owned on and off for the past twenty years. It is a national for-profit education provider specializing in professional training. DeVry has built a very strong brand in the for-profit education world, buoyed by strong cash flows, excellent long-term performance and prudent management. We originally bought the stock in 1991 when the company first went public for $1.16 per share. Its current price is $54.11 per share. In summation, what J.M. Smucker, T. Rowe Price and DeVry all have in common is their sound financial discipline that allows them to anchor their businesses and protect them from economic downturns or business volatility. Q:  How do you construct your portfolio? A : We have a concentrated portfolio with anywhere between 30 and 40 names. Stock weightings reflect conviction and the underlying risk-to-reward ratio. We are benchmark-agnostic and have risk controls. We do not allow a specific industry to exceed 10% of its weighting in the portfolio, and we do not allow an individual name to exceed 5% of the portfolio. Q:  What sources of risk do you identify in the portfolio and how do you mitigate them? A : As followers of a value investing discipline, we believe risk is best defined as the permanent impairment of capital—in essence risk equates to losing money.  Everything else we consider relating to risk, both our controls and our monitoring, falls underneath this belief.  We use four key risk controls at Ariel.  First, across portfolios no issue shall represent more than 5% of a portfolio.  Similarly, no more than 10% of a portfolio will be invested in companies that do the exact same thing.  Third, in keeping with our Warren Buffett-like philosophy, we stay within our “circle of competence”—industries where we can truly be experts.  Finally, we compare individual stock prices to our calculation of intrinsic value on a daily basis.  One type of risk monitoring we conduct uses outside data sources.  As part of our external risk monitoring we use a program that allows us to evaluate factors such as leverage, P/E, beta, market capitalization and industry allocations versus the benchmarks.  Another tool is our “buy/sell list”—a chart that is updated weekly and used in senior research team meetings and portfolio management discussions.  This collection of data informs our stock-specific dialogue, helps identify potential issues and allows for additional follow-up as necessary.  Finally, we track the market sensitivity of our portfolios vs. our peers.  In doing so, we regularly check our own risk metrics versus our peers—standard deviation, beta, and other measurements that institutional investors watch.   We also have our own risk metrics.  Our proprietary debt rating supplements the public ratings assigned by external rating agencies.  A company’s debt rating examines four areas: where the company’s bonds are trading relative to treasuries; the pricing on credit default swaps; the interest rates on the company’s bank debt (if possible); and the nature of the company’s credit agreements and covenants.  Additionally, our proprietary rating system monitors the competitive "moat" around a business and any potential change to it.  A moat represents the set of competitive advantages a company has against its competition, including the company’s brand(s), client relationships, economies of scale, low cost manufacturing position, cost of capital and so forth.  We also carefully consider whether a company’s moat is increasing or decreasing—obviously we prefer the former.  Finally and most recently we instituted a system that monitors the sell-side ratings of our stocks, which enables us to see whether consensus on a stock is getting too optimistic (a risk in our view) or too negative (a potential opportunity).