Q:  Would you provide a brief history of the Westport Select Cap Fund? A : Westport Asset Management, Inc. was established in 1983 by Andrew Knuth and Ron Oliver with a singular focus on investing in small capitalization companies for institutional clients. Ed Nicklin joined the firm in 1997. The Westport Fund and the Westport Select Cap Fund, which were established in 1997, have the same investment philosophy and process. However, the Westport Select Cap Fund differs from the Westport Fund in terms of the concentration and market capitalization of portfolio holdings. Through price appreciation of holdings, the Westport Select Cap Fund has evolved from being a small-cap fund to a mid-cap fund. Q:  What is the investment philosophy behind the fund? A : We like to buy shares of good businesses at what we believe are attractive prices or stocks trading at a discount to their intrinsic value. Our investment philosophy is based strictly on a long-term focus of trying to provide superior returns over long periods of time to what a passive investment vehicle might provide. Q:  How do you convert this philosophy into an investment strategy? A : The fund invests primarily in common stocks of small capitalization companies under $2 billion at the time of purchase. We will invest to a limited degree in companies that have larger capitalizations. We employ a bottom-up stock picking approach. Once a potential investment is recognized, we assess the intrinsic value of each company by estimating what a strategic buyer would pay for the whole company and what the market is willing to pay for a comparable stock. Our goal is to own a relatively small number of high-quality stocks with a disproportionate amount of upside to downside risk over a two-year period. We sell a stock if it reaches a predetermined price target or if the company’s fundamentals deteriorate. Q:  What is your investment process? A : The investment process starts with identifying companies that are out of favor with Wall Street. Above all, we aim to discover good companies that are having transitory problems. The evaluation process includes fundamental research, company visits, and management assessment. We dig deeper into the company’s balance sheets, cash flow and management teams. For us, idea generation is event-driven and does not depend on quantitative screens. Our belief is that a negative event often results in a significant stock price declines creating an unusual opportunity to buy a high-quality business at an attractive valuation. The key factor is determining if the problem is going to change the earnings power or the cash-flow generation of that company or if it is a transitory problem that is going to be resolved in a reasonable period of time. We look for factors that are different relative to the market. For example, we believe that investment opportunities also come in the form of corporate turnarounds. If we believe that the management will be able, over a reasonable period of time, to take the necessary corrective steps, we will establish a position in that stock. Other considerations in play would be a good balance sheet, some free cash flow and more importantly, if it is the kind of business we want to invest in over long periods of time. Next, in many cases we tend to talk to management. Our analysis involves understanding and evaluating the company’s problems that need to be rectified and assess the management’s strategic plan to improve profitability within the timeframe of a turnaround or resolution of the problem. If the management has a logical explanation what the problems are with the business and a well thought out plan to resolve the problems, we could be very interested in that particular stock. We are very patient provided the management has a well thought out plan and then follows the plan. Another characteristic that we examine in the portfolio is a company’s ability to generate free cash flow. Naturally, free cash flow gives management an opportunity to take a number of initiatives such as buying back shares, making acquisitions or restructuring a business. Q:  Would you shed more light on your research process by providing some examples? A : A perfect example would be Baldor Electric Company. For many years this U.S. manufacturer of quality electric motors has run its business with a policy of avoiding layoffs. The company implements this policy by reducing the amount of hours workers are on the job. Historically the stock has been relatively highly priced. However, early in 2007 Baldor made an acquisition of the Reliance Electric Company from Rockwell in a cash deal worth $1.8 billion. This acquisition was risky in the sense that Reliance roughly doubled Baldor’s size. Nevertheless, Baldor made steady progress after the acquisition, combining facilities and reducing excess personnel through attrition. We began to see the fruits of their efforts in late 2010 as the economic environment improved. The U.S. market for high-efficiency motors was estimated to grow 10% to15% in 2011. This was something that Baldor had prepared for well over a year in advance and that indicated to us further revenue growth and corresponding profit increases. Another significant event that took place on November 30, 2010 was ABB Ltd.’s agreement to acquire Baldor Electric in a deal worth $4.2 billion wherein the shareholders of Baldor were to receive $63.50 for each share held. The combination of ABB and Baldor will introduce high efficiency electric motors in Europe and other countries. Moreover, ABB had a significant hole with respect to their operations in the United States that Baldor fills. The projections of free cash flow that Baldor and Reliance could generate and use to deleverage the balance sheet played out very, very well for us and the company as well. The next example to cite would be Del Monte Foods Company, which also has a significant position in the Westport Select Cap Fund. They are a producer, distributor and marketer of branded pet products and food products. When the company returned to the public market it was not interesting, because the business was dependent on franchise business growers and the size of the crop. But what changed was the company’s acquisition of the pet foods business from Heinz as well as some other product areas in 2002. The key here was that the move added a component of packaged goods to what was otherwise an uninteresting product line. Then, in 2006, Del Monte added to the food and pet snack business by buying Meow Mix and Milk-Bone, which improved their position, making them a branded national pet food supplier. What is more, they also figured out ways of selling their traditional food products in more exciting formats. This is an example of an uninteresting company that changed its overall business mix quite positively as well as handling financial leverage. Q:  How do you construct your portfolio? A : We have a fairly concentrated portfolio with 35 to 40 holdings and the top ten names generally account for 40% to 50% of the portfolio. Individual holdings are typically 3%, while the largest positions may be as large as 10%. The portfolio turnover is very low, averaging less than 7%. We try to construct the portfolio in a way that provides hedges within sectors. We do have diversification within the portfolio to provide interesting possibilities and risk management for influences from the economy and markets. Since we are not interested in being closet indexers, we are not concerned about the weightings that we have across industry groups. Our average holding period is between seven to eight years. Q:  What are your views on risk and how do you contain it in the portfolio? A : In our opinion, risk is mainly created by imperfect knowledge. Our biggest risk control is the fact that we research companies ourselves. Other risk control measures that we employ are our understanding of a business and its fundamentals, and the financial strength of each company. We have a concentrated portfolio, which may lead to company-specific risk. Over periods of time this risk is mitigated by the fact that we buy quality companies with a healthy business model and the ability to generate free cash flow.