Q:  Would you provide an overview of the company? A : American Beacon Advisors was founded in 1986 to provide investment advisory services to institutional and retail markets. Apart from offering a variety of mutual funds, the company also offers short-term fixed income separate account management. The company also manages the American Beacon Funds, a series of low-cost mutual funds open to institutional and individual investors. The American Beacon Small Cap Value Fund was started at the end of 1998 and is principally managed by its sub-advisors. Q:  How many sub-advisors does the Small Cap Value Fund have and who are they? A : The Fund had five sub-advisors that are funded and two more that had not been funded as of May 31, 2010. The funded managers are: Brandywine Global Investment Management, LLC, Hotchkis & Wiley Capital Management, LLC, Barrow, Hanley, Mewhinney & Strauss, LLC, The Boston Company Asset Management, LLC and Opus Capital Group, LLC. Q:  What is the investment objective of the Small Cap Value Fund? A : The Fund is a multi-manager fund focusing on long-term capital appreciation along with current income through investments in small cap stocks of companies located in the U.S. Q:  What is the market cap in this fund? A : The Fund’s assets are invested primarily in stocks with market capitalization of $3 billion or less at the time of purchase. The portfolio holdings will usually be sold if they increase in market cap to $5 billion. Investments may consist of common stocks, preferred stocks, securities convertible into common stocks, U.S. dollar-denominated American Depositary Receipts, and U.S. dollar-denominated foreign stocks traded on U.S. exchanges. Q:  Do all your managers have a similar investment style? A : Apart from having a value style of investing, each manager follows his own investment process. All of them select stocks that in their opinion have above-average earnings growth potential and are also selling at a discount to their fair or intrinsic value. Even though the end goal is the same, each one has their own proprietary assessment models using a combination of internal and external research along with analysis of changing economic trends. Q:  How do you select your managers? A : Since we do not run the assets ourselves, we are quite careful when it comes to the selection of our investment managers. Initially, the Fund had two managers and we subsequently expanded to five as the assets under management have increased. While some multi-manager funds look for un-correlated managers, our managers tend to be highly correlated over long periods of time. They all have a similar philosophy of buying cheap but growing companies even though individual investment style may vary. Every manager I have ever met says they believe in buying growth stories. So, at American Beacon we use a mathematical model to determine, on an on-going basis, whether each company in a sub-advisor’s portfolio is growing sufficiently relative to the price he is paying for the stock. We use this metric periodically to assess our sub-advisors and make sure that they are still doing what we expect them to do. So, by design, we select sub-advisors with similar goals. How they arrive at these goals finally is left to them but we monitor their progress all along the way. Q:  Could you elaborate on the process of selection? A : We screen managers on their performance records in a very broad way. We look for firms that have median or better results in either the latest five year period or three year period. Once we have identified such managers, we take into account other factors in our further assessment. The team that is responsible for the last five years of performance must still be at the firm and the firm must have incentives in place for motivation and retention of such teams. As we look for long-term managers, we expect to see a succession plan in place for senior personnel taking over higher responsibilities in case of retirements. Finally, we spend a lot of time in getting to understand the process of the manager in constructing his portfolio. We need to establish that it is a good fit with our philosophy as described earlier. We want our portfolios to be made up of companies that are cheap today and expected to grow faster than the market in the next two to five years. Once we determine that the manager’s process is a good fit with our philosophy, we want to get our hands around their investment process. Generally, everyone talks about three Ps, people, process and performance required for a proper selection and I would add a fourth P to the three, patience. A good understanding of the process will allow us to have patience in our ongoing monitoring and assessment of the sub-advisors. Q:  How are these managers different in their stock selection approach? A : Hotchkis & Wiley is a traditional value manager. They do fundamental research focusing on different metrics and good balance sheets. In short, we describe them as a price-to-normal earnings manager. They try to estimate their candidate’s earnings five years out and then make an assessment whether those candidates have the ability to return to normal earnings level. Brandywine Global follows a process of exclusion. Instead of finding out which names to include they go about excluding those names from their universe that do not fit their requirements. They exclude all those names except the lowest 25% by P/E or price-to-book. Then they look back nine months and exclude all those that have had poor price momentum in that period. When they are through with these exclusions, they have a universe of about 350 names from which they weed out the ones that have poor fundamentals and some critical issues. Eventually, that leaves them with 250 to 275 names which they purchase on a market cap weighted basis. They tend to maintain a diversified portfolio of approximately 275 companies. Having Brandywine Global as one of our managers has allowed us to keep the Fund open to new investors longer, because they have more capacity than other managers. The third manager, Barrow, Hanley, Mewhinney & Strauss, whom we added in 2003, is a traditional value manager. They are the most concentrated manager with around 35 names. Being very sector agnostic, they focus on price-to-free cash flow yield and focus only on companies with good balance sheets and with good management. The Boston Company is quite traditional with a diversified portfolio of about 150 names. They are very research-focused and spend a lot of time finding out the most suitable metric for each of their candidate companies. They look for businesses that are in a position that enables them to generate free cash flow, where temporary controversy has been priced in as permanent and where a catalyst for ending the controversy can be identified. They are very risk conscious, with sector and industry constraints. The fifth manager is Opus Capital who does a lot screening up-front. They screen for low P/E, low price-to-book value and low price-to-cash flow. They look for low P/E divided by growth plus yield and they also focus on companies with high earnings surprises and revisions. Q:  How do you allocate assets to your managers? A : Ideally, we would like to allocate assets equally to all our managers. We have confidence in all of them and expect all of them to deliver good returns long-term. But, we definitely cannot say which one of them will perform better in the next quarter or the next year. Today, for instance, Hotchkis & Wiley and Barrow, Hanley, Mewhinney & Strauss are both closed and are only growing by appreciation. The other three managers are open to us for allocations. Each is given assets depending on their remaining capacity. Q:  By having these five managers, what risk parameters are you taking out at a broader level? A : We think that value is inherently a risk control. We also mitigate the risk of underperformance by a single manager when we have multiple managers, as all of them are highly unlikely to underperform at the same time. Furthermore, we have broad diversification rules in place to control risk. Once these firms are hired, we give each one an identical set of guidelines in addition to what is in the prospectus. These guidelines further limit them in terms of security, industry and sector allocations to limit over exposure to any of them, as we do find some overlaps across the five portfolios, which is natural since all five are traditional bottom-up value managers. Q:  How do you control sectors and individual weightings in the fund? A : There are about 500 names in the Fund in total. The largest holding is typically from 1% to 1.5% as the guidelines prevent overexposure to any one single name. We also have a guidelines that limit them to investing no more than 15% in any one industry. At the sector level, the sub-advisors may own the larger of 30% or the benchmark weight in any sector. We also limit our managers from owning too big a slice of a name even if it is only a small piece of the portfolio. Thus, we limit our managers from owning more than 2% of a company’s total market cap. Q:  Out of the total 500 names owned by all five managers, how many names could be overlapping at any given time? A : We have found that about 90 names are common across the five portfolios but rarely in all five of them. Q:  What are the other advantages of a multiple-manager fund as compared to a single-manager fund? A : Our Fund has an attractive expense ratio for individual investors, starting at 112 basis points. For institutional plans and larger investors, such as 401-K plans, the expense ratio is only 85 basis points. We are able to offer more capacity and our Fund tends to remain open longer because of the multi-manager model. Additionally, we do not drift away from our style box. In this case, the Fund is a value fund that focuses on smaller companies only.