Q:  What is the history of the fund? A : The American Century Real Estate Fund, which was launched on September 21, 1995, seeks high total investment return through a combination of capital appreciation and current income. Q:  Why do you invest in REITs? A : The real estate space has a low correlation compared to stocks and bonds. We find the primary driver of a REIT’s performance over the long term in the commercial real estate industry fundamentals which are driven by supply and demand. In addition to long-term total return characteristics from commercial real estate, exposure to REITs also provides diversification to a client’s portfolio. And finally, there is an income component with the average REIT yielding about 3% today. Q:  Would you underline the main principles of your investment philosophy? A : Our investment philosophy is a mix of a top-down and bottom-up approach. We emphasize fundamental research without marrying growth at a reasonable price. As a total return investor in the real estate space, we try to beat the index on an annual basis in both up and down markets by doing internal research as well as using external sources for information for the portfolio. Q:  How do you allocate within the property sectors? A : In our benchmark, the MSCI US REIT Index, there are several core property sectors, and they would be industrial, office, retail, apartments, healthcare, hotels, and self-storage. The bigger sector – apartments – stands for about 18% of the index while retail between two subsets is about 25% of the index. By determining which regions of the country are showing the best fundamentals for real estate, we tend to overweight or underweight these property sectors in a timely manner. Moreover, our opinion of the economy is reflected in an offensive or defensive portfolio among the various property sectors that we can invest in. Q:  What is your investment process? A : As mentioned earlier, we are about half top-down and half bottom-up. Our benchmark has about 130 portfolio candidates, of which we tend to cover about 110 of the largest names. On the top-down side, we look at macro factors such as strength of the economy, interest rates, as well as regional strengths and weaknesses and supply/demand characteristics for the various property sectors. As part of our bottom-up approach, we cover the list of potential holdings by ranking them based on a couple of metrics. The first characteristic would be stock price to net asset value per share, whereas the other metric where we put a lot of weight is the price-to-earnings ratio divided by growth rate. We also evaluate the management team’s approach based on their past and current strategy and how successful they have been in implementing it in a timely manner. We insist on understanding whether it is a strategy that would be rewarded in the stock market and thus become a factor in the long-term growth rate for the company. Finally, we assign about a 10% weighting to dividend strength. Since we invest in a finite universe of 110 or 120 companies, we have to look harder for inefficiencies or opportunities within our universe, which calls for our combined top-down and bottom-up approach in search of maximizing the portfolio. Q:  What are the analytical steps that your research process involves? Could you illustrate with a few examples? A : We are looking for companies with a minimum equity market capitalization of $400 million. Apart from the index we also cover some non-benchmark names, which would be real estate companies that are not REITs but that own income producing real estate. In our research process, we meet with companies and tour properties to get a feel for the quality of the assets and the strength of the local management teams or properties. We are committed to evaluating the strength of the asset versus the competition on location. Then, we assess the company’s management team to gauge their past achievements and the likelihood of successfully executing this strategy for their company going forward. At that stage we put together a three- to five-year earnings model for the company in order to get an appreciation of what the earnings power would be like in the foreseeable future as well as to review the balance sheet and their financial flexibility. As a further step in our process, we will categorize which property sector the company belongs to. Our team meets every day to discuss REIT ideas, and because the investment universe does not change that dramatically year-to-year, we are looking at the core names on a fairly consistent basis. For example, there is a hotel REIT in our coverage list that bought the Essex House Hotel in New York at a certain price. They were involved in a fairly sizable transaction, so we spent a lot of time assessing the appeal of buying the Essex House Hotel and converting it into a JW Marriott, and reviewing the upside into this investment after a yield guarantee from Marriott International. As we run into these research opportunities as a result of REITs that are making acquisitions or developing new properties, the general idea is to see how such developments have an impact on the attractiveness as well as the earnings power of the company. That is something we discuss on a daily basis. We put all the companies together on a daily valuation model, ranking them from 1 to 120. In this model, 1 through 35 would be a buy, then 36 through 65 would be hold, and 65 through 120 would be sell. Although we do not add more than five or ten new companies to the coverage list each year, we are constantly applying updates to the interesting names and we are looking for changes at the margin. A recent examples of the dynamics that we monitor is that property owners in, let us say, the Phoenix metropolitan area or Southern California have begun reporting accelerating earnings. In this way with the entertainment industry, technology industry or tourism we can see improvement and acceleration in the underlying growth for REITs that have assets in those markets. Conversely, one market that is starting to slow down is New York City, which has been one of the strongest markets over the last three years because New York has been a big beneficiary of lower interest rates. However, what has happened in the last six to nine months is that the stock market trading volumes have been very modest with the increasing regulation of banks, and so the expansion of financial services has slowed down along with the leasing momentum in New York and the asking rents in the area. As a result, we have become more negative on New York-centric office REITs. Q:  How do you execute your asset allocation in the portfolio? A : Generally speaking, for the core property sectors we would be comfortable going anywhere from 50% to 150% of the benchmark weighting. For some of the smaller property sectors we can allocate anywhere from zero to the benchmark weighting 200% of the benchmark weighting. In our top 10 holdings we like to have positions anywhere from a 100 to 150 basis points overweight each of those names. In terms of absolute size, the largest REIT in the index is Simon Property Group, Inc., and they are 10% weighting in the index. We have about 11.5% weighting in that stock today, meaning we are 150 basis points overweight Simon. Our largest overweight position right now is a shopping center REIT, Taubman Centers, Inc., the owner of upscale regional malls, where we are 150 basis points overweight. We usually have a weighting of maybe 300 or 400 basis points overweight the index weight. For instance, in healthcare if the index weighting was about 15%, we could go up to 18% or 20% weighting in the fund versus the 15% weighting in the index to have an overweight and generate some alpha. Q:  What drives your sell discipline? A : As a whole, our sell discipline is based on our daily valuation model. For instance, if we bought a stock ranked number 20 in the model and after a period of time we saw some price appreciation moving the stock down to number 75, that would be a flashing yellow signal for us to reevaluate positions and consider selling it. Additionally, if we had a change in sentiment about the market fundamentals, we would sell a stock. Q:  Are you fully invested at any given time? A : At American Century, the guideline is that we can have a maximum of 3% cash, and today we are running with about 1.5%. We prefer to run around between 1% and 2% cash with the fund, so this is essentially a fully invested fund in REITs at all times. If we were to get particularly negative about the market, we could go to 3% cash and move to some of the more defensive sectors. Q:  How do you build your portfolio? A : We would start off with our benchmark, the MSCI US REIT Index, as we look to go overweight or underweight the various property sectors and/or the various names to generate outperformance. The number of holdings in the portfolio tends to be between 45 and 50 stocks and the fund currently has about $1.4 billion in assets. We have good liquidity to implement buying and selling of stocks and enough concentration to generate alpha for investors. The 10 largest stocks comprise about 45% of the index weighting. In terms of regional exposure, we also have the flexibility to go 10% international, but as of this moment we have zero percent weighting internationally. We have about 8% of the fund in non-benchmark names because we see some opportunities in income producing real estate that is outside of the benchmark but still has real estate characteristics. For instance, we own Weyerhaeuser REIT, which is a timber REIT not represented in the MSCI REIT Index. We own Weyerhaeuser because we think they are going to be a beneficiary of the recovery in housing in the U.S., which will eventually lead to an increase in the value of the byproduct of timber. A second reason to own the name is the fact that they have a homebuilder subsidiary. Another similar story would be PulteGroup, Inc., a homebuilder that we like since we believe we are currently in the second innings of the recovery in housing in the U.S. We think that investing in sound publicly traded homebuilding stocks will be an outstanding way to play the recovery in housing in the U.S. Occasionally, if we are to build up on the hotel sector, we have hotel REITs but we could also have hotel C-corporations such as Marriott International or Starwood Hotels. We have owned those names in the past as a way to enhance our weighting in the hotel sector. Q:  What kinds of risk do you focus on? A : Our list of potential holdings is a relatively finite universe. First of all, we focus on being overweight or underweight in these sectors in the names within our universe. We do not buy privately placed or 144A stock and we maintain no illiquid investments in the portfolio. Secondly, because we cut off at $400 million in the minimum market cap we not only try to own the more liquid names but we also factor in how long it would take for us to get an investment position in a company. We tend to be anywhere from 90% to 100% in terms of owning names in the benchmark, so risk in terms of style deviation is very limited in our investment area. We are very conscious of the weightings in the benchmark, meaning we go anywhere from minus 200 basis points to plus 200 basis points on individual names and anywhere from 50% of the benchmark weighting to 1.5% of the benchmark weighting for the various property sectors.