Q:  What is your investment philosophy when managing your clients’ money? A : Safe and cheap. We are seeking long-term capital appreciation by investing in securities that are primarily common stocks of well-capitalized companies. Everything we do is fundamental bottom-up research. For us safety means well-financed companies that have great balance sheets, talented management teams, a long record of creating value for shareholders, understandable financial statements with disclosures and are in businesses that we understand. Cheap means that we are attempting to buy these stocks at a discount to net asset value. We are underlying the theoretical liquidation value of the company. For us the estimate of NAV means private market value and is a combination of hard asset value and the value attributed to the franchise, going concern, management expertise and historical track record of creating value for shareholders. We are most definitely a value shop. I guess you would call it deep value, but we don’t define value as others do. We are very balance-sheet oriented, not necessarily concerned about earnings per share or where the stock is trading at a certain multiple. A company can be very cheap relative to its peers or its multiples, but if it doesn’t have a strong balance sheet, we’ll probably pass on the investment. Q:  How do you implement that value focus as part of your strategy? A : Our approach tends to lead us to companies that are more involved in doing creative things with real estate as opposed to simply buying it and putting it in the balance sheet and financing it. Most of the investments tend to be real estate operating companies, or REOCs, as opposed to real estate developing companies, or REITs. The real estate funds focus almost entirely on the REIT universe, but because we seek long term capital appreciation as opposed to current income, we focus on companies that are not required to pay dividends. The REITs are required by law to pay out 90% of their taxable income. For the most part REOCs are in the same business as REITs, but the operating companies are able to retain their cash flow and reinvest it in the business, in new acquisitions and development. They are able to continue growing through all cycles without necessarily having access to capital. The REITs, on the other hand, are not left with a lot of cash flow after paying those dividends. They have to be in the business of recycling their capital by selling properties and then reinvesting in something that’s going to generate a better yield. Although we are value investors, our portfolio looks like growth companies as it relates to real estate. These companies should be able to generate better year-over-year growth in both cash flow and asset value. We look at a lot of different places to find real estate value. We are not just sticking to the list of 100-150 real estate investment trusts, we are trying to find real estate value in all different types of places. Q:  Could you give some examples of your holdings? A : A number of companies in our portfolio are in the land development business. They have legacy land they’ve owned for many years at very low cost and now those legacy land holdings are being converted to better use through the real estate entitlement process. Those developments may include commercial, residential, multifamily resort and residential subdivisions. St. Joe is our largest holding. That’s a very dynamic company. For many years it was simply a timber company, cutting timber for the paper mill, they had railroad and sugar assets, etc. They sold most of their non-core assets and now it is a focused real estate operating company that’s on a terrific path towards more growth. We have several companies in the portfolio that you would not think of as real estate companies. For example, we own Kmart stock, which is now Sears Holdings. We were involved with Kmart both before and after they filed bankruptcy. We owned unsecured debt in Kmart and were actively involved in the reorganization process. Effectively, we bought common stock at the time of reorganization and brought the company out of bankruptcy. The company has been making money selling off real estate and created a huge pile of cash. Bought by Sears the stock has performed extremely well. But initially our downside protection, the underlying asset that gave us comfort, was the real estate, not necessarily the ability of that company to become a solid retailer once again. Another example of that strategy is the investment in Franks Nursery & Crafts, which was a chain of garden supplies, life plants and craft items. They had over 200 stores and the company has filed for bankruptcy twice, but the new reorganization plan is to sell the inventory and close all the stores. The company will retain a core of about 40 stores and will turn into a real estate company and redevelop those properties. It was a retailer, which now has become a real estate company. Q:  Could you highlight your research process? A : In the real estate world, the list of companies is a lot more finite than if you are looking for value in any industry. In the US, the list includes all of the REITs, the REOCs, the homebuilders. We look at mortgage companies, mortgage services, and title insurance companies, building material and supplies, anything that is directly related to the real estate business. Outside the US, we’ve made a number of investments in Canada, the UK, and we are researching companies in Hong Kong. Starting out with the potential investments makes research pretty easy for us because the list is not that large. We screen all the companies; we have a research team of senior and younger analysts tasked with looking for low price-to-book, cash versus debt, low earnings multiples, etc, and using different ways of screening to identify interesting companies. Since we know most of the companies, we have a general sense of their value. If it gets into our range, we do more due diligence and fundamental research. The research process is pretty standard. If we haven’t already had discussions with management, we do that, but for most of the REITs and REOCs we know the management. We go to their conferences, sit on the presentations, have one-on-one meetings, so it is easy for us to pick up the phone and call the CEO. We are one of the largest real estate funds today, so they are happy to take our call. We may or may not go out and see their properties. I think property visits are generally overrated. I can go and look at industrial buildings until my eyes glaze over, but the real answers are in the financial statements and the disclosures. Looking at the fundamentals in the office, crunching numbers, comparing the results to those of other similar companies and talking to local experts in the various markets is much more valuable. Most of the real estate companies today have gotten very good at providing not only good disclosures, but also very detailed supplemental disclosures, property by property listings, occupancy statistics, etc. We also deal a lot with the sell-side analysts their reports. We use them for background, not for recommendations, because we are zigging when most of the others are zagging. We like companies that are falling out of favor if they have strong balance sheet and a good management team. If they miss a quarter and sell-side analysts think the near-term is looking weak, that’s when something looks more interesting to us because we are not focused on what’s going to happen in the next quarter or the next 12 months. Our focus is 3 to 5 years. We take positions in companies at a discount to underlying value and we are very patient. If a security continues to go down, more often than not we end up buying it cheaper. Q:  What happens when something changes in the market and for some reason the investment doesn’t work out? A : We don’t do any kind of top-down allocation, we don’t try to pick sectors or geographic locations that we like. Our entire focus is on the companies themselves, on the fundamental bottom-up research. We are indifferent if they own hotels, shopping centers, if they are homebuilders and if they are in New York or Denver. It is all about the companies. We end up with a very diversified portfolio not by design, it is just the result of looking at what we think are the best companies and many of these companies have diversified portfolios themselves. Forest City, for example, is not only geographically diversified, but also has retail, multifamily, office, land development. So we have a diversified portfolio not because we wanted to be in those areas and property types, but because we want to invest in the best companies that can get through all the cycles and through any storm. These are the companies that are able to be opportunistic in market downturns, when others may be over-leveraged and have to sell property at low prices because they have too much debt. That’s where the safety factor comes in. The companies that we like are able to take advantage of market downturns as opposed to getting crushed by them. Not that we always make the right decision, but if you look at our turnover over the last 6 years, it has been less than 10%. We tend to buy and hold and hopefully prosper through the long holding period. The majority of this low turnover has not occurred because of our decision to sell the security. It has come mainly from resource conversions, such as mergers, acquisitions, going private, management buyouts, spin-offs, major share buybacks, etc. Typically, those involuntary conversions are profitable. Q:  Could you elaborate on your portfolio construction process? A : There is really no predefined structure to the portfolio. Over the last 6 years it has evolved consistently being concentrated. When we have high comfort level in a particular company, we like to own a lot of it. Our top 10 holdings comprise more than 50% of the portfolio and they haven't changed much over the last 5 years. As new money has come to the fund, we have continued to add to our core holdings. We build the portfolio around the core 10 to 15 stocks and then we add any new names that come up looking attractive to us. We are not afraid to look at some smaller cap companies even though the fund is almost $2.5 billion. If we like a company that has $200 to $300 million market cap, we may take a 5% position in the company and have a $10 million holding. But we invest in small companies within limits because we don’t want to own 20 to 30% of a small-cap company. We are very excited about the prospects of our investments in Canada and the UK. Also, we recently made a couple of investments in Hong Kong and are deeply involved in the research process on a few more. We have to rely on more outside expertise when we invest abroad so we spend a lot of time on getting educated. If we don’t have the expertise in-house, we can tap into the resources and the management of our holdings to help us understand investment opportunities in those markets. Q:  What was the rationale behind looking for companies outside the US? Why only these three countries? A : Canada was easy since it is actually closer than California. The disclosures there are very good, the accounting is very similar to the one in US and they speak the same language. It was easy for us to understand the Canadian companies and their value. We started looking at the UK a couple of years ago. It was a process of getting to know some of the management teams and getting comfortable with the price of real estate in London, which is nearly double the price in New York. The UK has quite a number of publicly traded real estate companies and there is enough mass to compare and choose. We’ve talked to a few Italian, French and Spanish companies, but they are not that exciting. In Hong Kong again there are a lot of publicly traded real estate companies, so you can make determinations and comparisons about which ones are cheap, which ones own good properties and which ones are in top locations. There is enough outside research coverage on Hong Kong companies so you can get educated pretty quickly. Q:  How do you handle the disclosure and transparency problems in Hong Kong and the situation where insiders control the government? A : We try to focus primarily on companies that are invested in commercial real estate. In residential developments, the government controls the land and they can affect the pricing. We are a bit weary about the residential builders, but as a proxy to what we think is a strong residential market, we have invested in a major residential property broker. It is in the middle of the residential market without the risk of land availability. They are involved both in the sale of new construction and resells. When new construction gets tight, there is big market for resells and they are getting their fair share. The other companies we are looking at have high quality office and retail properties and their stocks are trading at significant discounts to NAV. They historically trade at discount to NAV and we have to get comfortable with what we think NAV is. The rents for commercial properties tend to be a lot more volatile than in the US or the UK, so it is riskier investing, but there are quite a few companies that are extremely well-financed, with low debt levels trading at 50% or more discounts of NAV. Q:  What kind of risk controls you have in place? A : We are more concerned about investment risk than about market risk. As long as we are buying a well-financed company at a discount, we are eager to withstand whatever the market is going to do to that security. In trying to avoid investment risk, we avoid highly leveraged companies or poor management teams. We don’t overly diversify our portfolio to reduce risk. We don’t believe that diversification necessarily produces less risk. Most often, diversification is a poor surrogate for knowledge, price consciousness and control. Our risk is controlled by buying well-financed companies with great management and buying them cheap. Safe and cheap, not diversification, because diversification just leads to mediocre returns.