Q:  How do you implement this philosophy into an investment strategy? A : Firstly, we try to find small- and mid-cap companies with a clear business model and a solid franchise that are out of favor due to temporary reasons. In addition to that, we are searching for companies that have the financial resources to weather a full business cycles. While selecting the stocks of these companies, we prefer to consider names where we can see how a catalyst is likely to bring about a change in the near term. As long as we identify such an opportunity, we are willing to wait for a period of up to 18 months. As a price conscious investor, we generally prefer to invest in companies trading at a low multiple to book value, historical earnings and cash flows. When we set about evaluating a stock, we examine its valuation in the past based on historical earnings. Then, we also compare the company with its market peers, looking at other private transactions in the industry and our future cash flow projections. We measure the company’s valuation from different aspects to arrive at a range of values. Our analysts and portfolio managers are constantly monitoring potential investment ideas with the help of a truly team-driven approach. Q:  As a contrarian investor, how do you justify your investments in Japan? A : Japan is, in fact, one of the most contrarian ideas that we are currently exploiting in the fund, with 27% of the portfolio being allocated to the country largely because of the compelling stock value that we see there. First of all, this is a market with multi-decade low valuations. From a macro standpoint, Japan has the highest expected GDP growth for 2012 among the ten most advanced economies. Furthermore, the expected EPS growth in the Topix Index is over 60% and the stocks in the benchmark are still trading at less than one time their book value. When compared to the average market valuation in the U.S., where stocks are trading above two times their book value and earnings are not growing faster than 10%, this is definitely cheap. Historically, the recoveries in the Topix Index have been quite strong even though the market index has suffered some heavy losses in the last three decades. For example, a rally early in the bear market included a 60% gain from the previous low to a 1993 high. Other trough-to-peak gains, with the year of the bear-market peak, include: 44% (1995), 44% (1999), 80% (2003), and an impressive 136% (2006). Q:  What is your research process? A : We generate ideas in different ways, ranging from proprietary screens, industry conferences, trade journals and broker research, to relationships that we have developed in the industries. However, we do not rely a lot on Wall Street research. In addition to reviewing regulatory filings and management presentations, we talk to management teams and visit business facilities to get a deeper understanding of the companies that we are considering as portfolio candidates. We also maintain two separate stock watch lists on a regular basis. The first list comprises companies that not only meet our fundamental criteria, but also have interesting features that are worth exploring. The second list encompasses a group of companies where we have actually met with management as part of our preliminary research. At that stage we are just waiting for a reason, be it a catalyst or a better stock price, to start buying into the stock. Our team benefits from a number of proprietary screens that we monitor for various countries and sectors. While some of these screening methods help us in weeding down companies with significant amounts of debt, other analytical tools that we use revolve around cash flows and dividends. We present any of these ideas to the entire of team of analysts and portfolio managers to engage in an active debate on evaluating the merits of each individual idea. Q:  Would you give a few examples to better illustrate your research process? A : One of our favorite stocks is a company called Medikit Co., Ltd., a medical technology company that engages in the manufacture and sale of catheters and other medical devices in Japan. Historically, the company has been able to grow earnings in double digits, and it continues to serve the aging population in Japan. Although a major advantage for Medikit is the flexibility of their catheters, the main reason why we like the stock is its valuation. At present, Medikit is trading at about 12 times next year’s earnings estimates, with a little over $260 a share in cash, no debt, and a current stock price of around $330. In other words, 80% of its share price is in cash. If we net out the cash, the stock is trading at less than three times earnings, and historically the company has been able to grow earnings in double digits. Companies like Medikit offer compelling valuation to us, so we are keen on adding them to our portfolio. Another example would be a company that is no longer in our portfolio. So-net Entertainment Corp., a Japanese Internet service provider, was bought by Sony Corporation at a 71% premium, which might appear to be rather low relative to the overall value of the business, but shows how much value there could be in some of these businesses. We made a lot of money on that stock as it was already up before the takeout, so that was just essentially closing the gap between an $800 million enterprise value and the value of SoNet when factoring in its 50% ownership of another publicly traded company, which had on its books a “hidden asset” worth $3 billion total and therefore $1.5 billion to So-net. One of the secular themes that we have identified is that the world is going to add probably 1.5 billion people to the emerging middle class over the next ten years or so. As a result, many of the companies that feed directly into the theme are trading at ridiculous multiples. A relevant example of this type would be Clear Media Limited, a China-based outdoor media company that is primarily involved in bus stop advertising. The U.S. based Clear Channel Outdoor is the largest shareholder of Clear Media. What we like about Clear Channel is that they send in their own set of auditors as they review internal controls and transactions to make sure that there is no malfeasance or inappropriate transactions. What is more, companies like Coca-Cola, Apple and Samsung want to advertise actively in China, so Clear Media is growing double digits on the back of a solid blue chip customer base. Clear Media’s stock is trading under seven times next year’s estimates earnings. The company pays a dividend and currently has $135 million in cash and no debt on their balance sheet. Not only do they have a dominant market share in major Chinese markets such as Beijing, Shanghai and Guangzhou, but the their business is gradually growing its market share in 27 cities. To cite another example, we picked a company called KUKA AG, a German producer of industrial robots for a variety of industries – from automotive and fabricated metals to food and plastics. What we love about the company is that a newer mid-size lightweight robot is helping the company grow the number of applications on the industrial front. That development is especially favorable given that the general industry has roughly one-tenth of the robot density per worker when compared to the automotive industry. There is certainly a lot of potential for growth ahead of the company owing to the huge demand for their products in a marketplace with very few competitors. Having done quite well with the stock, we think that there is a lot of room for an extended run as the competitors are trading at much higher multiples. This is also an indirect way to play the growing emerging markets theme. Another global theme that we like to keep an eye on is water. One of the companies with a major contribution to the portfolio is a water utility in Brazil called Companhia de Saneamiento do Paraná (Sanepar), a provider of treated water, and wastewater collection and treatment services for the Curitiba region. When we came across that stock the company had not received any tariff increases for almost 10 years. That was happening at a time when the government was going to be replaced with a friendlier local government, so we were able to buy the company at a very low multiple. And subsequently, over the last two years they have received tariff increases of 16.5% in one year and 16% in the next, so it is a great situation that we have run into there. Lastly, Bombardier, Inc., the Canadian regional jet and locomotive maker, is a company that we know fairly well because other fund managers at Heartland have also been interested in them. Bombardier has spent a tremendous amount of money on their C-series, the new jet that is expected to start flying around year end. As of this moment, the market orders for the C-series have not been as robust as people had anticipated, because a large number of customers are still on the sidelines, waiting to see if the operating cost of this latest model is going to be 15% lower as originally promised by the company. In our view, the orders are likely to pick up as soon as people see that the actual operating costs are lower. Looking into the company’s backlog in Europe, we noticed that those projects are well funded and they have got a huge build-up in the locomotive and transportation sector. In the meantime, the company is also taking new orders for business jets. Consequently, we believe that the stock is going to pick up as the C-series is released and the market reflects the real decline in operating costs. Personally, I think that the C-series jet will enjoy a big regional niche in tier-two and tier-three cities in the Asian aviation market. All in all, Bombardier is a company selling at a very reasonable valuation that we expect to develop a book-to-bill ratio greater than one. Q:  Why do you prefer dividend-paying companies? A : First of all, dividend payment forces a company’s management to be disciplined on their allocation of capital. Dividend-paying companies also tend to have more stable cash flows which, together with the dividend itself, can help reduce volatility during turbulent times. Q:  How do you build your portfolio? A : We try to maintain a portfolio of 40 to 60 companies that meet all our criteria. Because we are broadly geographically diversified, we will not invest more than 35% of the portfolio in any one country. We certainly take political risk into consideration in order to avoid certain geographies that we perceive as risky. For instance, we are not involved in South Africa at this time because politically and economically we are concerned about the situation in the country. Historically, we have stayed away from Argentina and Colombia even though those markets have rallied at times. The reason behind our reservation is political risk, which we are monitoring along with other macro risk factors. At the core of our portfolio construction process, we seek to target a three- to five-year timeframe for our holding period. The fund’s benchmark is the MSCI All Country World Index ex USA Small Cap Value Index. Q:  What kinds of risk do you consider? How do you contain risk in the portfolio? A : Permanent loss of capital is a significant risk focus. We actively hedge certain currency risks in the portfolio. We feel that holding a concentrated portfolio of 40 to 60 stocks enables us to find good value for investors while staying broadly diversified among sectors, industries and countries. In spite of our reluctance to over-allocate in a certain country or industry, we will take in active risk in situations that we find attractive.