Q:  What is the investment philosophy that drives your investment decisions? A : The most important element of our philosophy is the focus on quality growth equities. We invest in companies that can sustain above-market growth rates for a prolonged period of time. In other words, we invest in companies that can grow stronger for longer. Therefore, we spend additional time evaluating the duration of growth, and that’s a key differentiator of the fund. The William Blair Growth Fund is a flagship product of the company. It has a long history - the fund was originally founded on March 20, 1946. The firm has about $35 billion in assets under management. We operate domestically, but there are funds in the William Blair family that operate internationally with the same investment philosophy. Q:  How do you define the quality characteristic of growth? What is the process that helps you in selecting quality growth equities? A : We look for companies that represent durable business franchises. That term probably best describes our philosophy. The durable business franchise has three pillars - a strong management team, a sustainable business model with a sizable growth opportunity, and a superior financial profile. When evaluating the management team, we look for a proven track record and for understanding the sources of their company’s competitive advantage. Such a team should undertake actions to sustain that advantage over prolonged periods of time. Hence, the company will continue to grow, not necessarily fast, but with high returns on capital and for a long period. In terms of the business model, we prefer companies that address large markets, even if they have a relatively small market share. We value the pure growth potential as well as the advantages relative to the competition. Sustainable competitive advantages can come from a variety of sources. For example, first mover advantage can provide disproportionate market share for years to come. The appropriate product and distribution strategies can create a loyal customer base with high costs for switching to a competitor’s product. Value sharing with the customer can create long-lasting advantage for companies that do not necessarily maximize their near term profits at the expense of customers. Innovation lets the company prolong and strengthen its positioning. All of those elements are important. Regarding the financial profile, we look for organic top-line growth and a healthy margin provided by value-added products or services and a loyal customer base. We expect the returns on invested capital to be greater than the cost of capital. In simple words, we look for companies that create true economic value. A healthy balance sheet is also important, as it allows companies significant financial flexibility. In our 50-stock portfolio, most of the companies have clean balance sheets, generate free cash and have self-funded growth, so they are not dependent on external capital for that growth. Of course, there are exceptions to these rules, but these are the core beliefs that guide our investments. Q:  How do you transform that philosophy into an investment strategy and process? A : We rely on a bottom-up, fundamental stock-picking strategy. We start with a very broad universe of stocks that surpasses the Russell definition of the growth universe. We have a quantitative team of three people, who provide models and tools for the fundamental research. We run all the stocks in the U.S. through their quant models for characteristics suggestive of quality and growth. In this way, we narrow the broad growth universe down to a quality growth universe. Any analyst or portfolio manager can take a stock from the quality growth universe and put it on the research agenda. Typically, we keep an active short list of 20 or 30 investment ideas, on which the analysts are working daily. Sometimes companies make it to the research agenda directly from first-hand experience. Q:  Would you describe your research process? How does a stock become part of the portfolio? A : We are not top-down sector rotators and we don't try to time the market. We put the portfolios together from the bottom up, based on our idiosyncratic insights into specific companies. Once a company is on the research agenda; the due diligence of our research team starts. The goal of that work is to qualify every candidate as a good or a bad investment idea. The due diligence is based on the durable business franchise model that I already explained. If the analyst comes to the conclusion that this is a true quality growth company, the portfolio manager may decide to get involved in it. Our analysts also look independently at secondary and industry sources before they come up with their fundamental investment thesis. We use the advice of experts not only to verify the management’s statements and the specific business case, but also to discover the success factors in a given industry. We want to know what differentiates a good company from a bad one in this particular sector of the economy. In the end, the analyst gives a rating of the company. Then, together with John Jostrand, we evaluate the risk-reward profile of every ‘buy’ stock in comparison to our existing holdings and other ideas. We try to build a portfolio that maximizes the expected risk-adjusted return, while respecting certain parameters or constraints. The final component of portfolio management is risk management. The analysts usually spend 90% of their efforts on business fundamentals and the business model, while the portfolio managers deal with the valuations. Of course, the analyst provides a sense of the real value of the company relative to the sector, but the portfolio managers usually have a broader view of the overall stock market. They have a sense of the valuations across the different sectors, so we reserve most of the final judgments for John Jostrand, the co-manager of the fund, and to me. Q:  What is the typical structure of the portfolio and how do you approach diversification? Do you have any specific rules and limits on sector exposure? A : The number of stocks in the portfolio has consistently been in the range of 45 to 55, so it is a fairly concentrated portfolio. We add value through stock selection, through a differentiated view on the ability of a company to grow stronger for longer, and through exploiting the inefficiencies in market pricing of that growth. Because we rely mainly on our strength as stock pickers, we prefer the portfolio risk to be stock-specific risk, not industry or market risk. Our benchmark is the Russell 3000 Growth Index. We are not market timers and we don’t try to take advantage of macro views on when the market is going up or down. Likewise, we're not aggressive sector rotators and generally have exposure in all major sectors. We add value by identifying quality growth stocks that are underpriced at any given time. Of course, when there is extreme overvaluation of a sector, such as the technology bubble, for example, we would go to more pronounced deviation from the index sector weights. One of the main features of our fund is that we have an all-cap growth strategy, so we do have exposure across all market cap sizes. We do place limits on that exposure, however, because we don’t want to swing from 90% small-cap to 90% mega-cap positioning. The idea is to offer a truly multi-cap fund. So, small caps can represent up to 30% of our portfolio, and we define them as companies with market cap of less than $3 billion. Mid-cap companies are in the range of $3 to $15 billion, and our exposure to that sector is between 20% and 50%. Large-caps are greater than $15 billion and we hold between 35% and 75% there. In the last three years, the distribution in the portfolio has been approximately 20% in small caps, 32% in mid caps and 48% in large caps. Q:  Could you give us some example of stock picks that illustrate your thought and research process? A : One of our current holdings is Idexx Laboratories (IDXX). It is a good example of a mid-cap company that is a durable business franchise. It provides instruments, chemistry and blood analyzers, and digital radiography machines used in vet labs to conduct diagnostic tests. More importantly, it sells the consumables for the instruments, and those consumables are necessary for any test. What attracted us is the innovative management team that's been together for a long time. Idexx started as a production animal company and then it recognized a massive opportunity in the companion animal space, and made a strategic turn. It is deeply penetrated in the veterinarian market in the U.S. and Europe; it is the market leader in a relatively fragmented sector, which grows at a healthy rate. And they don’t simply rely on the installed base and the organic growth, but continue to invest in new ideas, like software, for example. Financially, the company has an operating margin of about 17% and good return on capital, based on organic growth. We believe that it can maintain between 15% and 17% growth during the next five to ten years. On the large-cap side, I would give the example of Apple, which has a great franchise and a highly innovative company. We also own Hewlett-Packard, which is not the greatest growth stock in the world, but is a reasonably valued complex company that sustains 14% growth for a long time. Q:  What is your view on risk? How do you control and monitor it? A : An important differentiator of our fund is that, although we are an all-cap investor, our risk profile is very similar to that of an average large-cap growth fund. That’s unusual because in terms of standard deviation and absolute risk, small-cap stocks represent significantly higher risk than large-cap stocks. But our risk profile is also a function of the quality element of the portfolio, and that’s why it resembles the large-cap risk profile. Despite having double-digit weight in small-cap growth stocks, our companies tend to have no debt and have great operating stability. In general, our portfolio has half the leverage of the growth universe. The nature of the business models that we are able to identify leads to more similarities with the large-cap universe in terms of risk. The limits concerning the sector bets and the market cap exposure are also part of the risk control. We monitor the standard deviation of the portfolio and we’re aware that if we add high volatility stocks, the overall risk profile from an absolute risk perspective will go up. We also use traditional tools, such as Barra risk measurement, which show how much we can deviate from the Russell 3000 Growth. We run monthly analysis of our portfolio, which keeps us aware of the real composition of risk within the portfolio, and helps to make sure that the majority of our risk comes from stock specific risk, not from unwanted industry or factor risks. Above all, I believe that our philosophy and deep knowledge of the companies make us very sensitive to where the risk or the potential pitfalls are from a fundamental point of view. Ultimately, the clean balance sheets and the cash generative nature of most of the businesses represent another way to mitigate risk.