Q:  What are the underlying principles of your investment philosophy? A : Markets are generally volatile, but the magnitude of volatility differs from sector to sector and from one industry to another. Our investment philosophy is rooted in profiting from this turbulence to take advantage when there is fear in the market and walk away when investors are euphoric. Our industry and sector rotation investment strategy is based on measuring one company valuation at a time and comparing it with the stock price. At its core, our philosophy revolves around calculating and selecting better relative value. When the price of a stock is below company valuation we closely evaluate other fundamental factors, and when the price exceeds significantly above our estimate of valuation we are not averse from selling. We believe that with the help of industry rotation we can not only preserve gains in the portfolio and avoid severe corrections, but also generate overall returns that are ahead of broader market index-based returns. Q:  How do you transform this philosophy into an investment strategy? A : Through our proprietary valuation model, we seek to identify undervalued securities that are poised to become the next market leaders. Broadly speaking, we find sectors that are undervalued on a relative basis and tilt our portfolio toward industries displaying the best value on a relative basis as well as leadership potential. As part of our efforts to capture market themes through industry rotation, we track 1,500 companies in our domestic company database that runs across 154 industries. We evaluate each individual stock using the modified Graham and Dodd valuation model. After we categorize and create a ranking list of every single company in each of these industries, we will then develop a similar ranking for each sector. We use industry classification developed by Standard & Poor’s Global Industry Classification Standard. Once we have actually classified the individual stocks within each industry, we continue with our review of value on a relative basis. Our valuation model enables us to calculate the intrinsic value of a company and compare that to the market price of the company in order to generate the price-to-value ratio. Any price-to-value ratio above 1 suggests that there is an upside opportunity in a stock, or that it is a bargain, whereas on the flip side, a ratio below 1 would mean that the company is overpriced and we should avoid it. From a bottom-up standpoint, we start with the 1,500 price-to-value ratios to calculate an average price-to-value ratio for each of the 154 industries and rank them by value. As a result, we obtain the average price-to-value ratio for each industry, which helps us tilt the portfolio towards those with the highest price-to-value ratio respectively. In addition, we track ten sectors so that we can also work out an average price-to-value ratio for every particular sector. Q:  How do you calculate value? A : There are four variables that we generally consider when determining value – an earnings base; forward looking long-term growth rate; beta or stock price volatility; and the yield on the company bond. First of all, we begin by rolling out earnings into the future with the help of the forward looking long-term growth rate. Then, we discount it back to the present, adjusting for risk through beta and interest rates or company-specific bond yields. Because we do not want to inflate value, we use a lower long-term growth rate in our model. This method of calculation gives us an indication of intrinsic value of the company, which we compare to the market price of the stock. We do not calculate the value of companies that do not have earnings or that appear to be losing money. One of the most interesting stories of how value can be very deceptive if we do not adjust for the proper growth rate is Amazon.com, Inc., the online retailer. Back in 2000, they had not made money, yet people were bidding up for the stock. Since Amazon had not proven itself at all, we completely avoided the company at that time. Amazon is a great example of a company that was not posting positive earnings and the price was being bid up because of the Internet frenzy. We avoided it because, for a company that is not earning money, it is hard to justify value in it through our model. The marketplace was bidding up their stock, but from our valuation standpoint it did not make a lot of sense. Q:  What are the main analytical steps in your research process? A : At our quarterly valuation review we carefully look at long term growth rate for each company and we adjust the model based on the latest financials available. All other company-specific variables are also reviewed and updated before we generate a revised ranking for all the companies on the list. Bed Bath & Beyond is a good example of this process. We saw that the earnings forecasts were lower than the market had generally anticipated and the stock sold off significantly. As a rule, we do not look at one quarter or a single headline in order to make our investment decisions. We calculate what a company is worth based on a long-term valuation model, and we often see opportunities in times when the company may be going through a poor quarter. Not only do our models guide us in determining what the intrinsic value of a company is, but they also allow us to gauge where the company stands in the industry compared to its peers. Our model is also constructed on the premise that value is often created by fear. We try to exploit the combination of fear, which creates investing opportunities, and greed, which can cause investors to bid up a stock to more than what it is worth. Overall, we need three years of positive earnings, analysts’ coverage, and long-term growth rates to be able to value a stock. For example, Facebook Inc. does not presently have enough data that we can confidently evaluate. Even though the name is in our database, there is simply not enough earnings history to actually review the company. We search for consistency in profitability and controlling costs over a long period of time because we want to see a track record which gives us confidence that the company is well managed. By ranking the industries and the companies within them that have the most value and the best quality ratings, we complete the whole analytical cycle. Q:  How do you build your portfolio? A : Based on our relative value approach to sectors and companies, there might be times when there is a significant split between industries with a lot of value compared to industries with little to no value. As mentioned earlier, we drill down into those industries with the most value, whereas at a company level, we rank the individual stocks within each industry, assigning base weight allocation for each stock in line with the value and management quality ratings. Having established the average price-to-value ratio for each industry, we follow this bottom-up process to scrutinize the numbers for each industry before we make our portfolio construction decisions. For example, the internet retail industry is overpriced, according to our value-to-price ratio calculation. However, that assessment only applies at an industry level, meaning that there are going to be some stocks in the industry that have value. At this point, we believe that Amazon.com, Inc is significantly overvalued, so it is a stock that we would stay away from within this industry. Our ranking system assigns 1 as the highest quality value point and 5 as the lowest. In our portfolios, we prefer to select companies with management quality rating of 1 and 2. The number of names in the portfolio depends on our industry exposures. As of this moment, we have 31 holdings, of which 14% are in the cable & satellite industry due to the currently high levels of value. We utilize our valuation methodology to look for the best industries where we see mitigated risk and we are willing to concentrate. Our benchmark for the fund is The Standard & Poor’s 1500 Consumer Discretionary Index. Q:  What kinds of risk do you monitor and how do you contain risk in the portfolio? A : The first significant risk is the idea that there could be value in a stock when, in reality, there is none. We attempt to mitigate that risk by being conservative in our assessment of the long-term growth rate that we use in our model. That is a very important risk control in our process. Another measure of risk control that we have in place is our emphasis on the quality of management rating. If we believe that there is value in a stock but the company’s management has been erratic over the long run, we will be concerned that while there appears to be value in the company we cannot rely on management to continue to create shareholder value. Consequently, there is a serious risk that the value could fall towards the price of the stock rather than the other way. Furthermore, we control risk in the portfolio by including the risk of default for each particular company. To this end, we use bond yields to calculate our valuation with precision. In addition to these three significant ways of controlling risk, we also include beta or stock price volatility in our model as another risk mitigation tool. We are more comfortable with risk at the industry level because at that stage we are not necessarily buying one stock but two, three or even four depending on the industry, so if we can diversify into several high-value stocks within an industry, we are willing to take on a little more risk.