Q:  What is the history of the fund? A : Dean Capital Management, LLC is an investment advisor located in Overland Park, Kansas and an affiliate of C. H. Dean, Inc., an independent and privately held asset management and financial services firm headquartered in Dayton, Ohio. C.H. Dean, has been advising individual, institutional and corporate clients since 1972. Dean Capital Management, LLC, which was formed in March 2008, has served as the sub-advisor for the Dean Small Cap Value fund since June 2008. I am the lead portfolio manager for the Dean Small Cap Value Fund while receiving research support from Kevin Laub and Doug Leach. Patrick Krumm, our client portfolio manager, rounds out the Dean Capital Management team. The investment objective of the fund is long-term capital appreciation and dividend income. Q:  What are the underlying principles of your investment philosophy? A : As traditional value investors, we believe that focusing on high-quality companies that are undervalued for transitory reasons can lead to above average returns. We define “high quality companies” as companies with high returns on capital, minimal or manageable financial leverage; and companies that are self-funding through high free cash flow that preferably pay a dividend. We believe industries that are temporarily out of favor serve as fertile ground for finding long-term investment opportunities. We look for a market leader in a niche business that can take advantage of dislocations in its industry when that industry might be struggling and the market is neglecting it. In our view, risk-adjusted performance can be enhanced by emphasizing stocks that exhibit the best risk/reward relationship. Therefore, we seek stocks that exhibit an asymmetrical characteristic consisting of limited downside risk with meaningful upside potential. Our belief is that the small-cap arena is one of the least efficient places in the market, which gives it a lot of potential for good risk-adjusted returns over time. Q:  How do you define “small cap”? A : We define “small cap” as companies with market capitalizations that are similar to those in the Russell 2000 Value Index. The largest company currently in the index is $4 billion, but we try not to add new companies that are over $3 billion in market cap. Generally, we are willing to go as small as the trading volume will allow; we have no constraint on the downside other than volume. In fact, we pay more attention to volume than market cap as we do not want to be constrained by liquidity. Q:  How does your philosophy translate into an investment strategy? A : We utilize a multi-factored valuation method to identify companies that are trading below intrinsic value or that may have been overlooked by the marketplace. We consider such factors as a company’s normal earnings power, its discounted cash flows, as well as various ratios, including the price-to-earning, enterprise value to EBITDA, or price-to-book value ratios. We evaluate companies using a fundamental, bottom-up research process. We seek to preserve capital in down markets and to diversify the portfolio in traditional, as well as relative value-oriented investments. Q:  What is your investment process? A : Our screening and ranking system is industry specific. We tend to favor stocks of companies that have minimal debt, pay a dividend and have steady earnings. The companies that will show up on our radar are the ones whose stocks are trading inexpensively relative to normalized earnings and have a high return on capital. We also look for stocks that have historically been less volatile than the market with a narrower range of outcomes. We calculate normalized earnings over a full business cycle for every company we purchase. For us, it is more prudent to focus on a longer time horizon by looking three to five years out as opposed to focusing on what a company might earn in the next year. By doing this, we eliminate the tendency to allow emotion to cause extrapolation of the most recent trends. We believe normalized earnings provide a stable number upon which we can calculate valuations that are comparable across companies and sectors. Q:  How do you go about calculating normalized earnings? A : Normalized earnings are calculated internally. We produce a model for every company we own, which includes a balance sheet, cash flow and income statement. We use this to study returns on capital, average margins, and growth rates over a period of fifteen years. We also take into account the business environment a company has been operating in over the last fifteen years and whether that is going to be similar or different compared to the current or future environment. In other words, we are trying to understand what has happened in the past, what is happening now, what is going to happen in the future and, above all, how all those factors affect our normalized earnings number. Q:  What is your research process? A : Through our stock screens and ranking system we narrow the entire small cap universe to a manageable number of companies. We then try to choose 50 to 75 of the best risk/rewards to construct the portfolio. We create a financial model for every name in the portfolio and then do a deep dive on the research to understand the company’s competitive positioning and normalized earnings power. In conducting our research, we perform an in-depth study of the company’s public filings, and utilize all public information we can find to help form an opinion. We also rely on a trusted research network, which includes various research services including some Wall Street research. Ultimately, we are looking for companies with high free cash flow generation, high returns on capital, and market dominance in a niche business. We also want these companies to be trading at attractive valuations. In addition to our internal screening, we generate ideas through contrarian sector/industry analysis, activist investor filings, and former holdings. We emphasize companies with strong fundamental characteristics trading at compelling valuations, all while managing stock-specific risk by ensuring that we have good downside protection in the stocks we own. Our downside protection comes from studying the balance sheet and understanding how much leverage a company has or where there might be hard asset value that would provide a floor for the stock. We also favor dividend paying stocks for the downside protection the dividend provides. Basically, we are trying to identify those out-of-favor stocks where the market is under appreciating the normal earnings power of the business or the value of the company’s assets. By looking out three to five years or over a full business cycle, we feel we can take advantage of the market’s tendency to be shortsighted. In terms of our sell discipline, we sell a stock from the portfolio if it reaches its price target, fundamentals deteriorate, or it can be replaced by a better idea. Q:  Could you elaborate on your research process with a few illustrative examples? A : A good example of a company that we own is Courier Corporation whose principal activity is to print, publish and market books. This is a great example of a neglected industry with electronic books being such a hot product right now. It is a cheap and underfollowed stock because the popular opinion is that electronic book readers are the future of book reading, while ignoring the niche areas where e-books cannot replace old fashioned books. But what is interesting about Courier Corp. is the fact that one of its biggest customers is The Gideons International Organization. The Gideons give out Bibles for missionary work, which is a business with a very stable base that is not going to go away because you’re not going to give an e-book as a missionary gift. The company has historically had very high returns on capital over time, it generates a lot of free cash flow and it has a very good balance sheet. It currently pays nearly a 5% dividend yield and management has been buying shares. Courier is a leading player in the book manufacturing industry, largely due to this niche with Gideons and we think the market is overlooking it. Another area where we have been seeing attractive investment opportunities is in the banking industry. This is our largest industry weight with nearly 25% of the portfolio invested in small cap banks. We own a basket of 17 bank stocks that we believe can take advantage of the current dislocations in the banking industry by acquiring failed institutions through FDIC-assisted transactions. FDIC-assisted transactions can generate a tremendous amount of value for shareholders of the acquiring firm. These types of acquisitions instantly increase the acquiring bank’s normalized earnings power, book value, and franchise value with very little risk as the FDIC usually shares in 80% of the losses of the failed bank. Our prime example to illustrate the potential from these types of situations is First Financial Bancorp out of Cincinnati, Ohio, which is one of our largest holdings. They announced two FDIC-assisted transactions in September 2009. Prior to the acquisitions, the stock was trading around $8 per share. Following the acquisitions, and after the market recognized the earnings potential of the deals, the stock is now trading at just under $20. Another example of a company that we have owned since June 2008 would be Steak ‘n Shake, which is a fast food restaurant franchise that is highly concentrated in the Midwest and the South. It was a company with solid brand recognition, but the previous management team was more interested in “growth for growth’s sake” versus increasing return on invested capital. Activist investor Sardar Biglari agitated for change while garnering a seat on the board and eventually becoming Chairman and CEO. Since gaining these titles, Biglari has dramatically slowed the store growth and rationalized the store base while turning around the operations in the existing restaurants. In addition, Biglari is changing Steak ‘n Shake into a holding company structure where he uses the cash flow generated from franchisee royalty streams to invest in unrelated businesses that offer what he feels are the best opportunities for return on invested capital. Meanwhile, he has changed the name to Biglari Holdings to alleviate the stigma a potential acquisition target might have from being acquired by a fast food company. Steak ‘n Shake is a good example of the type of situation we think will be instrumental in driving outperformance in the future. Q:  How do you construct the portfolio? A : We typically own a portfolio of 50 to 75 names, the majority of which have market capitalizations of less than $3 billion at purchase. We build the portfolio from a bottom-up, stock-by-stock basis. To ensure diversification, we have certain sector guidelines. Sector weightings are typically kept within 15% of the benchmark Russell 2000 Value Index. Our policy requires that no holding can be greater than 5% of the total assets of the portfolio at purchase and no greater than 7% at market. We also stay fully invested over time, which means we typically will not hold more than 5% cash. The average turnover in the portfolio is around 150%. Q:  What risks do you perceive in the market and how do you manage them? A : There are a number of risks perceived in the marketplace. First, we focus a lot on company-specific risk and control that mainly through the valuation that we are paying for the company and understanding our downside protection. Second, we control risk through our portfolio management techniques and weightings for our companies. We tend to favor and give larger weights to those stocks that have narrow range of outcomes and have low expectations from the market. Finally, we try to control risk through our turnover. We scale in and out of our positions, which helps minimize volatility over time and allows us to take advantage of the emotional swings in the market.