Q:  What is the investment philosophy and objective of the fund? A : The SunAmerica Focused Small-Cap Value Portfolio invests in high-quality companies with industry dominance, strong management aligned with shareholder interests, strong balance sheets and earnings potential. Our philosophy is based on the premise that owning the best for less enables outperformance. The fund seeks long-term growth of capital by investing in companies that are small in market cap and have a growth profile that is not recognized by the market. Q:  Why do you prefer the value style of investing? A : Value investing has been empirically proven to be one of the ways to outperform market averages over many business cycles. Small cap value investing offers opportunities to capture inefficiencies in small caps within the proven value discipline. We believe that, within value investing, there are sub-styles that can be characterized as deep value, absolute value, early cycle cyclicals, relative value, growth at a reasonable price, late cycle cyclicals, momentum at a reasonable price, and contrarian. By investing in stocks within the various sub-styles that are likely to outperform depending on where we are a business cycle, we believe superior results can be achieved. Q:  What is your investment strategy? A : The SunAmerica Focused Small-Cap Value Portfolio employs a concentrated, stock-picking process within the small-cap universe with returns generated principally via stock selection versus sector allocations. The fund seeks to invest in undervalued and underfollowed companies with a bias towards quality firms with strong management and dominance in their industries. Our selection process is driven by fundamental analysis and our idea generation is driven by screens among the various value substyles, themes that we believe are secular and long-term in nature, and many years of hard-earned investment experience. Q:  Would you describe your research process? A : We have an experienced team. Each of our analysts average about 10 years of investment experience. Our analysts are sector specialists and are expected to know what is happening in their areas of expertise. We determine which substyles of value we think are positioned to outperform, identify stocks of interest from our substyle screens, discuss themes that we particularly like and then our analysts research names of interest in depth. We start out by conducting thorough research on the company’s history. We talk to company management and their competitors, suppliers and customers on a regular basis to get a good sense of the business, the dynamics that are driving it., prospects for growth., and risk factors. We have a strong preference for companies that exhibit dominance within their industry, either by market share, profitability, assets or superior management talent. Not only do we do research at a company level but we also try to develop a strong understanding of the respective industry dynamics. It’s always better to try to buy the best company in an improving industry versus buying the best company in a worsening industry. Q:  Would you illustrate your research process with a few examples? A : An example of what we thought was a contrarian idea is Vonage Holdings Corp, a provider of voice services over broadband networks to traditional long distance and local telephone service from the large incumbent telephone companies. Vonage was probably one of the worst IPOs I ever saw during my career. It went public in 2006 at $17/share and went straight down to $0.31 by 2009. When we first started tracking the company in late 2009 it was under-followed with only one sellside analyst covering the stock despite being taken public by some pretty well known Wall Street firms. That analyst didn’t have anything nice to say about the company at the time. They had a weak balance sheet having executed a $200 million debt financing in 2008, paying a whopping 20% interest rate. What caught our attention from our screening work was that the company appeared to be improving it’s cash flow for several quarters and had a seemingly stable revenue base of about $900 million coming from 2.4 million subscribers. A new CEO, Marc Lefar, had joined the company that appeared to have experience in helping to turn around troubled telco companies. We visited the company’s headquarters and met with the senior management team. What we learned was that Lefar and his team were working hard to improve the customer experience, improve quality, develop a streamlined platform to roll out new products and services, and reduce customer turnover. They simplified their offerings and marketing message and they also identified a potentially large growth market with the Hispanic population in the U.S. In fact, the company developed and executed an entire call center and sales and marketing program to address the Hispanic population. They hired a new CFO, Barry Rowan, who we knew had a track record of turning around Nextel and selling it to Sprint for a huge gain. Rowan was able to further cut costs and refinance the high cost debt that was on their balance sheet. Vonage was our largest position in the portfolio last year and it is still currently our largest position. The stock was up 60% in 2010 and is up over 100% so far in 2011. We think that considerable upside potential exists as they execute on their growth strategies. Another example is US Gold Corporation, a gold and silver exploration company. This stock selection was a combination of our experience in valuing exploration companies and an important investment theme. The theme we felt that was important to recognize was that monetization of debt, that is the Federal Reserve buying bonds from the Treasury Department, was going to happen and that would create tremendous demand for tangible assets globally. Gold has a wonderfully long history or surviving all paper currencies. Our understanding of the history of investing in precious metals mining stocks is that when the metals go up, the exploration company stocks tend to go up the most. US Gold is run by Rob McEwen, who we knew had a tremendous track record in founding and growing Goldcorp which is now over $42 billion market cap. After McEwen left Goldcorp, he decided that more money could be made in exploration companies and he got involved in a number of them, investing a lot of his own money in each. US Gold is one that we thought to be particularly compelling, with attractive land packages in Nevada and Mexico and increasingly attractive high grade gold and silver ore sample discoveries. McEwen’s reputation, experience in advancing an exploration company into a major producer, ability to assemble a world class team, backing it with his own money, and having a very attractive land base were the main drivers for us in selecting this stock. US Gold’s stock rose 225% in 2010 and is up over 15% in 2011. It is still a large position in the portfolio. Q:  How do you go about constructing the portfolio? A : We are tasked with having a focused portfolio with 30 to 50 names. Studies have shown that the best performing active managers concentrate their best ideas among the top number of names. So I think it is a wonderful discipline to have in a product is designed to capture those best ideas and not get our performance overdiversified into mediocrity. Typical weightings per security is a meaningful 1% to 10%. As for sector diversification, we range from 0% to a maximum of 25% per sector. Since financials represent currently about 37% of the Russell 2000 Value Index, it should be understood that we will underperform if financials are the only thing that is working. But knowing how illiquid many small cap financial stocks are, we also think it prudent not to have that high a level of exposure to financials. We work diligently in the craft of stockpicking and we build our portfolio one stock at a time. We seek to find the best ideas that have the best risk-reward potential. Better ideas should crowd out lesser ideas and wonderful ideas should be overweighted meaningfully. Our portfolio should not be anything resembling an index fund or an ETF, but I think it is well designed and, if executed properly, should appeal to investors looking for capital appreciation over the long term. Q:  What is your buy-and-sell discipline? A : Our buy discipline is based on our preferences to wait for the right stock price and to getting the timing right in terms of identifying a catalyst that is going to work within a reasonable period of time. We sell a stock if it is underperforming on a relative basis for an unacceptable period of time, or if our thesis is wrong, or if fundamentals deteriorate. Also, if we have a name that has worked well but there is another idea that comes along with a better risk-reward profile, then the idea that has done well could become a candidate for selling. Getting out of our losers early, not taking big losses, overweighting and riding our winners are rules that we follow quite diligently. Q:  How do you define risk and what do you do to contain it? A : The most important risk to us is not understanding what we own. To us, not knowing what drives the business and what could potentially go right or wrong is the biggest risk. When the level of certainty goes up, our weightings should go up, when the level of uncertainty rises, our weightings should decrease. The other important risk factor is knowing the level of risk the overall portfolio should have relative to which way the market is going. If the market is trending higher, names that have a good record of outperforming in rising markets will tend to be weighted more heavily than names that perform better in sideways or falling markets.