Q:  What is the history of the company and the fund? A : The Dreyfus Mid Cap Opportunistic Fund dates back to September 1995 and has grown to $1.8 billion in size today. We also use the same strategy to manage assets for institutions. The strategy was designed to outperform the mid cap and mid cap value indices over time. We are benchmark-agnostic, and we will go opportunistically where we find the best value in the market. That could be a growth, core or value stock that is priced below our estimate of the company’s intrinsic valuation. Mid cap stocks have been the best-performing U.S. asset class over the past 5-, 10- and 20-year periods, and we were one of the first investors to launch a standalone mid cap fund. Our belief was that mid cap companies could potentially give you the best of both worlds. They offer the dynamic and singular focus of smaller cap companies without some of the risk that comes with small cap securities. They also can provide better alpha opportunities than larger cap companies, which are generally fewer and have even fewer opportunities to grow. We thought the intersection of those two things made sense. In general, investors have not been interested in the mid cap asset class for the last ten years. We think this is a mistake. Inception to date, our fund has beaten indexes and been a leader among its peers. Q:  What is your investment philosophy? A : The core tenets really start with value. We believe that all investment philosophies need to begin with value, understanding how much you are paying for a security. We value securities the same way we have over the last 20 years: We look at the long-run intrinsic value of the business. Intrinsic value contemplates what a reasonable and well-informed investor would pay for a security. We also believe fundamental research is a key differentiator. You cannot understand a business without really getting your hands dirty and kicking the tires: talking to management, researching the competitive environment, evaluating the suppliers, understanding how pricing is determined, and appreciating how supply and demand are working in the industry. The last key tenet is that we believe in a risk-managed approach. The strategy is benchmark-agnostic, although we are aware of the benchmark’s construction. Big deviations from the benchmark will come in large measure where we see capital risk for clients. If we see sectors of the market with high downside price risk because of fundamentals or relative value, we will avoid them altogether, even though they may be popular or present in the benchmark. Q:  What is your investment strategy and process? A : Our approach to the investment process started over 20 years ago. We have evolved and improved the process over time, but the core beliefs have not changed. By design, we are looking at a very broad investment universe of about 800 securities. We then identify the most attractive opportunities and create a working list of target ideas. With eight investors, we have one of the largest small and mid cap fundamental research teams in the country. That gives us the advantage of being able to turn over more pebbles to look for opportunities. We believe that the way to win in this business is to have lots of horsepower going at a very inefficient asset class, which is the mid cap universe of U.S. stocks. We build our working list by looking at screens, but rather than running the same screen, we will run much more targeted screens. We also meet with hundreds of company management teams each year. That drives a lot of idea generation. Some of it is just done through the mosaic of thinking about how the macro economy impacts the micro economy, maybe sparking an idea or two. For example, we know capital spending in the U.S. today is depressed. We would look for stocks that have been impacted by that and could benefit as capital spending comes back. Once a stock is on our working list, we recast our research. Our research process is really focused on understanding primarily the long-run intrinsic value of the business. We do that by estimating the cash flows and earnings that the business can generate over time and using a discounted cash flow technique to ascertain fair value. Our research is also focused on ascertaining the three attributes that drive value. First is determining the long-run growth rate of the business. We focus on how much the business can grow relative to the broader economy. We are not talking about one, two, or three years, but longer term. Second, through a lot of fundamental research, we estimate the business’s long-run return on invested capital minus its weighted average cost of capital. We do this to understand how fast the business can grow without additional capital and to analyze the amount of cash flow the business will generate over time. The last attribute in our discounted cash flow model is to understand the predictability of the business. This basically rates the quality of the management team. How likely is it that the business will look the way we have forecasted it in three, four, or five years? As an example, we give lower predictability rankings for software companies, where the future business is very difficult to predict. We would give much higher rankings to a trucking business, where we have better odds of forecasting the long-run business model. We also estimate the long-run cash flow and intersect that with the true assets and liabilities of the business. We look at the balance sheet to determine which assets need to be marked up or down according to fair value, and we do the same thing on the liability side. We use public financial documents to do that, and we also interview and do primary research with industry players to understand those values and the competitive dynamics for the business. In a nutshell, our research focuses on the level of competition both today and in the future, the power of suppliers, the power of customers, and the corresponding sustainability of profit that comes from those factors. In many ways, we are valuing a business much like a private investor who plans on owning the business for a long time. From that work, we get a very good picture of intrinsic value. We find good opportunities where the discount is bigger and where fundamentals are more likely to improve in the short to medium term. One of our analysts will then do a relatively long write-up, discussing fair value, risk in the security, comparable industries, and other factors I’ve mentioned. My job is then to play devil’s advocate, working with analysts to understand their beliefs and determine if anything was missed. When we agree on the facts, we seldom disagree about whether a stock is a buy, sell or pass. That is because we have hired like-minded people who are all using the same investment processes and philosophies to pick stocks. Once we have agreed on all the facts, if we like the stock, it is a buy and I determine the final position. Three things help us determine position weights. First is the relative risk-reward of the security, meaning how much upside there is to fair value versus how much downside there is to the worst-case outcome we have modeled in the stock. Second, we look at analyst conviction, or edge. It is a soft measure of how good of an idea we think it is and how differentiated our view is. Lastly we use quantitative risk models to understand how much risk each security brings into the fund. So if we have a stock that has a fantastic risk/reward, we think we have a very differentiated view on it, the analyst has a lot of conviction in it, and it is driving very low risk in the fund according to the tools we use, it would be a very large position. Q:  How do you look for opportunities? A : We believe the best securities lie at the intersection of four things: favorable idiosyncratic characteristics, attractive industry dynamics, supportive macro conditions and a mispriced security, for one reason or another. Often, our best opportunities are stocks with good long-run businesses, but with short-term problems. Investors have a tendency to misprice stocks in the short run. They are very focused on next year’s P/E as a metric to value stocks. We think this is a flawed metric unless next year’s earnings are representative of the average earnings a company can earn over a period of time. We are agnostic about the types of business we own. We like high-quality businesses that are reasonably priced. We like low-quality businesses that are reasonably priced. We try to cast as wide a net as possible over time. Say we’re looking at a fashion retailer that missed the spring selling season, and the stock is down a third. If there is nothing wrong with the fashion retailer, it might be an interesting security for us to own if we can ascertain that the next fashion cycle, as well as its competitive advantage, have not changed. If we are looking at a health care company, we can do bottom-up modeling, talk to doctors and understand the research pipeline. If we can understand clearly that the earnings, while low today, can be much higher in the future as R&D starts to manifest higher profits, that could be interesting for us. If we are looking at a technology company and through our primary work and conversations with management, competitors, suppliers, and industry players we can figure out that the next product the management team is running is better than the last one, and the stock is not discounting that improvement, that is a great security for us. If we are considering the chemicals industry, or any type of commodities industry, we spend a lot of time looking at industry supply. We like to buy securities in those spaces where supply and demand are sustainable and the price of the security is very low. We generally like to buy the stocks when their forward price-to-earnings ratio is high and we like to sell them to the market when the forward P/E ratio is low. We’ve also found that utilities often get mispriced in front of a rate case or when there is higher uncertainty. We think the success of any business — an investment business, a shopping mall, or a trucking company — hinges on understanding your process and your competitive advantage. It is also about hiring the right people. Finally, it is having perseverance and a solid belief in the first two factors. Q:  What is your portfolio construction process? A : Our investment process is continuous and it doesn’t stop once we own a stock. We are constantly monitoring fundamentals by looking at public documents, talking to management and performing primary research. If there is any deviation from our original thesis, the reason that we purchased the security, it is sold. We may also sell if the risk/reward is not attractive or if we find a better candidate for the fund. We value the stocks the same in every industry in the market. We are not using different valuation tools in different industries because in essence all stocks are the same. They generate cash flow and because of that they are worth something. In some cases, the cash flow is further in the future and other times it is more up front, but all stocks should eventually go toward a long-term cash flow potential. We spend the vast majority of our research time focused not just on what the company can earn in the short term, but more on what it can earn over a very long period of time. We call that mid cycle earnings or cash flow. Our research models will look different in that we are not just forecasting earnings over the next three to four years, but also focusing on the normalized level of profits. In some cases, the normalized profits would be significantly lower than what the company is earning. Today, this might be true of some commodity mining and equipment companies in the U.S. market. In other cases, such as in some of the consumer durable sectors or capital spending side of the U.S. economy, normalized earnings may be higher than what the companies are earning today. We also have a strong willingness to be opportunistic investors. We aim to be patient, to be different, to try and drive long-term performance for clients and not worry about tracking an index. We believe our job is to drive alpha for clients and separate ourselves from the benchmark. Ultimately, this business is about looking at a lot of securities in a disciplined, repeatable way to find the best opportunities for clients. Our process is designed to research an enormous quantity of securities and, when necessary, to go as deep as humanly possible into a company’s fundamentals. One of our key competitive advantages — besides the people on our team and the fact that we have been running the process for a very long time and know it works — is our ability to be more patient with and confident in our securities than the market is. We believe that if a security is mispriced, we should buy more as long as our thesis is intact. We set price targets for every security. It is one of the most important parts of our process because it defines how much upside there is to intrinsic value. As we set our target prices the same way all the time, we can sell on the next bubble early. Q:  How do you define and manage risk? A : We think risk is a good thing to have in funds; it’s needed to generate returns. However, the risk assumed should be identified, understood and be reasonable relative to investment objectives. It is my job to manage risk as a whole. I think it is flawed to talk about sector weights or security weights as risk management, because those are not important on their own. Rather, it’s how these things all interrelate. For instance, if someone is overweight by 300 basis points in industrials, consumer, technology, financials, energy, or commodities, in what seem like small overweight, they happen to be all in areas that are very highly correlated with economic growth. We analyze risk at a factor-level basis, such as exposure to price-to-book, price momentum and earnings growth. We also try to ascertain our exposure on an economic basis, such as to interest-rate shocks, inflation shocks, yield-curve moves, or the price of oil and housing. Over the past nine years under my leadership, our risk has averaged about 5% on a predicted basis, and we expect that to continue. This is our standard deviation of predicted tracking error, and we use tools from Barra and Northfield Investor Analytics to understand how much risk we are running in the fund. Then we try to focus the risk in idiosyncratic and de-emphasize systemic risk. We estimate about two-thirds of our risk comes from idiosyncratic and one-third comes from systemic. Those ratios can move over time depending on existing market opportunities. We used to run a more diversified portfolio, but we found that the diversification was not helping performance or lowering risk. So we spent more time on risk management and reduced the number of holdings. Our holdings today average about 65, plus or minus 10. One thing that came out of our research of prior returns was that our top securities in the fund outperform our lower position weight stocks. As a result, it makes sense for us to run a more concentrated fund as we believe we can drive better alpha for clients. I think there is an enormous amount of risk in the business. You have people risk in terms of hiring the right team members and overseeing them appropriately. The vast majority of my job on the team is to understand the people we have hired, the risks they are taking and the work that they are doing. Another risk is that your process is not evolving with the market. We are firm believers that the market and our competitors are getting smarter every year, so our process needs to improve and advance over time, using new techniques, different research, more thorough research, and more back-testing. Then, as I mentioned, there is portfolio risk. We think about risk at the portfolio and security levels. Lastly, we look at all these risks tied together. I would argue that one element is not more important than the other, but you have to think about how it all wraps together.