Q:  What are the core beliefs guiding the management of this fund? A : Our investment philosophy is to combine sound macroeconomic analysis with fundamental research in order to identify attractive investments. We believe that investing in undervalued small-capitalization companies will provide long-term capital appreciation. The first thing that we do is pick companies that have unique characteristics and a competitive edge. Secondly, we take into account social and environmental factors, in addition to financial factors, in making our investment decisions. We look for companies that respect the environment, treat their employees as partners, encourage diversity in the workplace, support the communities where they operate, and insist on ethical business dealings. We will not invest in companies that manufacture alcohol or tobacco products, that are involved with gambling, or that manufacture weapons and generate electricity from nuclear power. Thirdly, we seek to determine the intrinsic value of a company and buy its stock at a discount. Q:  How is intrinsic value determined? A : First of all, we calculate the average price-to-earnings ratio over the last five years and if the current P/E is lower than the five- year average, it’s possible that the stock is undervalued. We do the same with the priceto- sales ratio and the price-to-book ratio, and we consider the stock undervalued if it is trading below its five-year averages. Furthermore, we do a present value analysis by trying to forecast earnings in the next five years and through discounting the five years of free cash flow back to its present value, we determine what the intrinsic value would be. Q:  Could you briefly explain your investment strategy? A : The fund invests primarily in stocks with market capitalization under $3 billion at the time of initial purchase. We like to buy companies that are growing faster than the rest of the economy and also trading at attractive valuations. Q:  What metrics do you use to evaluate companies that are unprofitable? A : We look at proxies which are price-tosales ratios or price-to-book values instead of price-to-earnings ratios when companies are not profitable. Over the last year, we have also invested in companies that used to be mid-cap, but are now small-cap. Q:  Can you tell us about some companies in your portfolio that have the “competitive advantage?”’ A : Ciena Corporation is a supplier of communications networking equipment, software and services that support the delivery and transport of voice, video and data services. The reason why Ciena has an advantage is the quality of the products it makes, and it has a great research and development team. Moreover, they have a lot of experience with the optical networking equipment, which gives them an edge, and it would be too difficult for a competitor to have products in the marketplace that would make Ciena’s products obsolete. Another example would be Teleflex incorporated, which used to make cables exclusively for industrial uses, but has since switched to manufacturing medical devices that rely on tools and cables needed for medical procedures. We think they have a competitive advantage because of their knowledge of tubes and cables and medical devices, but also they have a special edge because of their deep product knowledge in healthcare. We believe this company will be more profitable with more growth opportunities going forward so we have included this company in our portfolio. Baldor Electric Company is a marketer, designer, and manufacturer of industrial electric motors, mechanical power transmission products, drives, and generators. First, we like them from an environmental standpoint as they were the first to come out with Super-E®, an energy efficient electric motor. Second, they are a great place to work, and have a profit sharing plan where the company takes 10% to 12% of pretax profits and puts it in a fund and distributes it to their employees. About twenty-five years ago they discovered that a number of their employees were functionally illiterate. They were unable to read well enough to assemble the high-tech electric motors. So, instead of laying people off, they conducted literacy classes on the spot, which not only provided a better trained workforce for the company, but this education changed the life of the workforce. Baldor Electric follows our philosophy of respecting individuals and proves a great place to work. Q:  Could you give us some examples that illustrate your research process? A : Our investment philosophy is to buy undervalued companies that offer solid long-term growth prospects. To identify these stocks, we perform an extensive review process for each investment opportunity. At the core of this discipline lies a complete fundamental analysis of a company’s products, financial statements and management. Our analysts travel the country to meet with executives and industry contacts to accomplish this goal. After our fundamental business review, we produce extensive financial projections to determine how much a company is worth. Along with the numbers, we spend a lot of time analyzing risk and current business trends. To be included in the portfolio, a stock must have twice the upside potential versus downside risk. In addition, a company must possess a positive business catalyst that can push the stock higher over the next 12 months. We like to be long-term investors, and typically we will hold stocks as long as they are undervalued and the business fundamentals are intact. If a company is not meeting our performance expectations, we do an extensive review to determine if the business fundamentals have changed. Our team constantly monitors investment positions with the goal of providing upside participation with downside protection. For instance, after 2001 the stock of Ciena was extremely overvalued. This shows that, for us, it is not enough just to see if a company has some competitive advantage, but also to see if their stock is selling at a reasonable price in relationship to its expected future earnings. If we were to buy Ciena at $100 a share, that would be unacceptable. But if we are buying between $5 and $15 a share, it makes sense. Currently, our intrinsic value of Ciena is $28 a share. Our investment thesis for Ciena is based on the assumption that the economy comes out of recession in 2010 and that the telecom companies start ordering equipment again. Q:  What is your buy and sell discipline? A : We sell a stock when it hits the intrinsic value. When the stock reaches a fairly low value, instead of buying it all at once, we buy a small portion, perhaps around 1% of fund assets, and if the value goes down more, we will buy another 1%, and so on. If it goes up right away, we still have profit on the 1% of stock that we bought, initially. The other consideration is that sometimes the intrinsic value can change due to factors like margin improvement, better cost control, and higher sales because of improved marketing. Q:  What is the minimum target set for return on investment of a firm? How do you derive the return on equity of a company? A : We look at 15% return on equity. It does not necessarily have to be 15% every year, but the company has to average 15% return on equity or, going into the future, it needs to have the potential to earn 15% return on equity on a relatively consistent basis. We arrived at the return on equity percentage from our experience over the years. Q:  Could you describe your portfolio construction process? A : Our benchmark is the Russell 2000 Index, and our goal is to beat the index by at least 1% to 2% on a per year basis. We do our portfolio construction by selecting eligible companies from the total universe of public companies based on their social criteria. We then identify the investments to be included in the portfolio with the aid of a five-step process of fundamentals, financials, management, catalysts and security selection. First we want to understand the business, including its strategies, products and its market. Second, through the study of financials we develop a business model to determine a company’s intrinsic value. Third, analyzing management helps us gain a sense of the team running the company, including their use of capital and track record. Finally, we look for stocks 30% below our intrinsic value calculation. The only diversification constraints we have are the mutual fund regulations under the Investment Company Act of 1940, and essentially it is that no more than 5% of the total fund assets can be in any one name and no more than 25% in one industry. Those are the only two criteria in terms of diversification that we would really need to do; otherwise we just pick the best companies. Q:  What are your views on risk control and how do you mitigate risk in your portfolio? A : We use two primary risk avoidance strategies – one is the debt ratio analysis in combination with our efforts to avoid companies that overleverage. Our belief is that investing in small-cap companies that are overleveraged is a recipe for disaster. Choosing a company with unique characteristics such as a competitive advantage also helps to reduce risk. In addition, we employ diversification, which in our case means no more than 5% of the portfolio is invested in any one name. Q:  What is the reason for investing in the housing market given the current homebuilding scenario? A : We have invested in the housing market after reviewing the history of homebuilders. We found out that the last time they went in a downward spiral was in the early 1990s. The firms that were fairly strong and had good financials started moving higher about 18 months before the housing market picked up. We noticed that the homebuilders are currently selling at very low prices again. So we went through the homebuilders and picked up the ones that had the strongest balance sheets and those that were still having positive cash flow even though they were losing money. We picked out three or four of them and invested in them at prices that were very low. We looked at the past patterns and we felt that buying stocks early was advantageous compared to waiting for the housing market to pick up. Whenever that happened, it would be too late as the stocks would have had most of their gain. In the previous cycles, they tripled from the low valuation. Our perception was that the homebuilders in our portfolio were not going to go bankrupt. We expect the housing market to come back in 2010.