Q:  Would you give us a brief overview of the company? A : Brown Brothers Harriman & Co. was founded in 1818 and remains a private bank engaged in three major lines of business: investor services and markets; banking and advisory; and investment and wealth management for individuals and institutions. We manage approximately $6 billion in large cap equity assets, the majority of which comes from our traditional wealth management business. We also have a growing presence in the institutional market and the Registered Investment Advisor channel. The BBH Core Select Fund has been in existence for 11 years, but the current investment approach and team of professionals date to 2005. Q:  What is the current investment objective of the fund? A : The main objective of the fund is to provide investors with long-term growth of capital after taxes. To achieve this objective requires that we execute our two major goals: first, to protect the capital; and second, to grow it at an attractive compound rate over time. Our investment strategy, which be believe is highly differentiated, is designed to achieve those goals. Q:  Would you provide more information about this strategy? A : The key differentiator in our strategy is our exclusive focus on businesses that meet our demanding criteria. Specifically, we are looking for high quality businesses that provide essential products and services to large, loyal customer bases. Candidates for the portfolio must be leading companies in attractive industries, have strong competitive positioning, generate strong cash flow and returns on capital, and have excellent management teams that are skilled operationally and in the deployment of capital. We aim to purchase these businesses when they are trading at 75% or less of intrinsic value to create a margin of safety in the price. Another point of differentiation is our “buy and own” approach. We look at equity investing as if we own the business, not just a position in the stock. Instead of being focused on generating returns from trading, we look to buy shares at a discount to intrinsic value and then allow the business to grow and generate free cash flow over a long period of time. In turn, that cash flow can be used to benefit shareholders. By following a long-term approach we are also able to reduce frequency of trading and keep turnover low in the fund. We have a target holding period of 3-5 years. From a risk management perspective, we seek to preserve capital both on a portfolio and individual company basis – in fact, we have the explicit goal of not losing money on any single investment. When we are weighing the risks of an existing or prospective investment, we spend considerable effort identifying all of the factors outside of management’s control. We also try to spot low probability, high severity type of risks. Q:  How does this differ from other long-term core funds? A : We believe that a lot of other long-term core funds follow a probabilistic approach by which they are explicitly or implicitly assuming that they will make a certain percentage of poor investments and a certain percent of good investments. We follow an approach where we hope not to make any poor investments at all. We work hard to underwrite each individual company so that we have a high level of confidence that we will protect our investors’ capital in the long term. Q:  What are the main characteristics of your research process? A : In our research process, we divide the investment criteria into three types of attributes, namely, business, financial, and management. While looking at the business attributes we search for leading companies that provide something essential to a loyal base of consumers or business clients. These types of companies tend to share some common features, such as strong brands, advantaged business models, efficient operations and global distribution. Customer retention is very important, as it allows companies to market new products and services effectively and more profitably with the existing clientele. We are also focusing on businesses that are relatively transparent and where we have reasonable visibility over ten to fifteen years with respect to the industry structure. On the financial attributes, we look for companies that generate high returns on capital. This leaves them with excess cash flows that can be either paid to shareholders as dividends, reinvested for higher returns, or used to repurchase stock. We seek out companies with strong balance sheets and consistent levels of free cash flow. If the business is not self financing we would also like to understand the liability structure and repayment schedule, so that the capital structure is not in any way compromised even in the event of a weak economy. Regarding the third area, the management aspect, we are looking for leaders with superior track records of execution and prudent capital allocation. These are people that we can trust with our investment, basically people that have demonstrated skills over time to run the business for the benefit of their shareholders which should be their mission in the first place. We look at their track records over time and see how they have allocated capital in the past and also develop an understanding of how they plan to allocate it in the future. Q:  Doesn’t this reduce the number of candidates in your investable universe? A : Yes, it does. We actually find that there are relatively few companies that meet all the criteria and so our universe tends to be around 150 to 200 stocks. This is the preliminary filter from which we implement the portfolio selection. Q:  Is there any limit to market cap in your fund? A : We generally look for companies with a market cap of $5 billion and higher. Q:  How many positions do you have in the fund? A : It is a relatively concentrated fund of 25 to 30 securities, and we see that as the right way to meet our objectives. We feel that we have achieved significant diversification without limiting the contribution to the upside from any given name. Q:  How do select your universe of stocks and then how do you proceed to build the portfolio? A : We develop our universe of suitable companies by first finding those that fit our investment criteria. Our research team is organized in six different industry groupings, and the analysts in each area apply those criteria to identify the businesses with the best fit. Through this process, which is dynamic over time, we form our universe, or “wish list” as we often call it. Once we have established that a company fits well with our criteria, we undertake our due diligence and apply various valuation methods to determine our estimate of intrinsic value. As a guideline, we aim to purchase only those companies that are trading at 75% or less of our intrinsic value number. Q:  How do you arrive at this intrinsic value? A : Our valuation approach is based on discounted cash flow, discounted economic profit and other supporting work such as private market valuation and implied growth. We build long-term financial models using conservative assumptions and we make sure we are normalizing toward long-run profitability and sustainable growth. To understand the business itself, we do a lot of research to gather information about the company’s management team, their capital structure, industry structure, plans for future growth and risks – not only the competitive risks that are in their control, but also things such as regulatory risks that are not within their control. We regularly speak to management, customers, competitors, former employees, suppliers and knowledgeable industry contacts. We maintain written records of all such meetings for future reference. The due diligence work is collaborative, involving the analysts and portfolio managers, and takes sometimes months to complete. We also review our findings quite frequently to incorporate any changes in our thesis as and when they are observed. Q:  How do you allocate weighting in the portfolio? A : We try to have the top ten positions account for 40% or more of the asset allocation. These top 10 positions are those companies that have meaningful discounts to intrinsic value but also have an extremely tight fit with our criteria and the most visible range of long term outcomes. Q:  What is your turnover? A : Our turnover is generally low. This year in 2009 it was around 15% and ranged between 30% and 35% last year. In general we expect the turnover to be less than 35%. Q:  Which index serves as the fund’s benchmark? A : We are not benchmark centric in our approach to investing, but given the types of large cap companies in which we invest, the S&P 500 is probably the right index for comparison over a sufficiently long period of time. During bear markets, we do have an explicit goal of outperforming the benchmark index. Q:  What are the kinds of risks that you see and how do you mitigate them? A : The most important risk that we see is the prospect of losing money. We try to mitigate that by preserving capital in every position and also the overall portfolio. Over time, that discipline should be the most important driver of our long-term results. One example of a key risk is financial risk, especially as it relates to credit. When we became uncomfortable with the accumulation of inadequately compensated credit risk in the financial sector, we sold off the bank stocks that were in the portfolio in 2006. We did maintain positions in some financial sector firms, like Berkshire Hathaway Inc, The Chubb Corporation and Progressive Corporation, where we saw far more stable financial profiles. Another risk that we consider is long term inflation, but our investment criteria help us select companies that are able to perform even in inflationary periods due to their demand characteristics, brand positions or unique assets. For example, among our stock holdings we have Nestle, Coca-Cola and Diageo, all of which have strong and broad brand portfolios. Other holdings like Waste Management Inc. and Vulcan Materials Company have unique long term assets for which they can charge advantageous prices over time. It’s important that we also try and identify and assess the risks that are outside of management’s control. This could include things like regulatory actions, legislative changes, catastrophes and obsolescence. We want to avoid these high severity risks due to the obvious potential implications in terms of capital preservation. In our financial models, we often look at three situations: a bear market, a bull market and a normal market. Even though this is not an exact science, we do this to get an idea of the possibilities in order to be prepared for eventualities.