Q:  Would you provide a brief history of the fund? A : Westwood Management Corp. was founded in 1983 by Susan M. Byrne and is a wholly-owned subsidiary of Westwood Holdings Group, Inc. WMC is the investment adviser for the WHG family of mutual funds. The WHG SMidCap Fund is a team-managed fund that was founded in December 19, 2005. However, it was launched for institutional investors in 2002, and that was when we started this smid-cap product. The bulk of our assets are in separately managed accounts. Currently, we have approximately $2.4 billion in assets under management, of which $165 million are the fund’s assets under management. Q:  What are the core objectives of the fund? A : Our investment philosophy is to generate above average returns better than the market while taking less risk. The fund chooses common stocks that it believes are currently undervalued in the market. We find value in companies when we expect future profitability to be significantly higher than what current prices reflect. These criteria produce an asymmetric risk/reward profile, which leads to superior long-term returns. Q:  How does your investment philosophy translate into the investment strategy? A : The fund seeks to provide long-term capital appreciation by investing in equity securities of small- and mid-cap companies. The fund generally invests in companies with market capitalizations between $l500 million and $10 billion. The equity securities in which the fund will invest will be primarily common stocks, but may also include shares of Exchange-traded funds. It generally invests in securities of domestic companies, but may also invest in foreign securities and American Depositary Receipts. Q:  Could you define “value?” A : We define value in terms of quality. That means we are looking for high quality companies that in the long run are going to grow faster than the market and be able to finance their business. They have a very strong financial position. And often these companies are leaders in their sectors with a strong management in place. They‘ve got a firm strategy in place for the company. But the most important thing we focus on is companies that really stand out relative to their competitors. Another metric that we focus on while seeking opportunity in a company is the downside risk. And if that downside potential from the current stock price is more than 25% to 30%, we are not going to invest in it. We‘ll wait for a better price. We are trying to buy really high quality companies but at a price to where we have some skepticism priced in about its growth rate or how high quality the company really is. Q:  Would you illustrate your research process with a few examples? A : The fund focuses on ideas that have limited downside risk and the opportunity to generate earnings/cash flows that are higher than what the current stock price implies. We focus on three factors. Firstly, we rely on our own proprietary research. Secondly, we focus on risk and absolute risk. And then thirdly, we have a teambased approach. We are unique in that we don‘t employ a star system and have no pyramid structure. Our research process is a three-step process. The first step is the analyst picking the ideas, the second step is reviewing the ideas in a group, and the third step is constructing the portfolio. We run screens to bring the universe down to a manageable size. We also look at financial metrics like strong free cash flow, stable-toimproving return on equity, improving balance sheet, and positive earnings surprise without a corresponding change in Wall Street estimates. We‘ll take a deeper look at the fundamental changes taking place inside at company that is causing us them to grow faster than the market expects. Once an analyst has an idea that they think is interesting, we try to identify the different drivers of the business and what those drivers are going to look like both on the positive and the negative side. We look at both on and off balance sheet liabilities. We think analysis of off-balance sheet liabilities is hugely important as it can help to avoid a lot of volatility that’s out there. We have different metrics for evaluating companies. For instance, for an oil company like E&P we focus on the earnings, the balance sheet, and the cash flow and what the company would look like for the next few years if the oil prices stay at $35 a barrel. For a bank, we would look at the book value and price-to-book. A key area of focus for us is looking at the downside scenario. And we are looking for no more than 25% to 30% downside risk in a security. We also look at the upside potential by building our own earnings models to forecast a company’s growth faster than what the market envisages. We‘re looking for upside potential over three years that is at least three times our downside risk. That is what we call that asymmetric reward risk that we are always looking for in a stock. The process is based on picking stocks at the right price with that asymmetric reward risk. We think that‘s how we can control risk in the portfolio. For example, Aptargroup, Incorporated is one of our holdings. The company manufactures and distributes dispensing products, and it is a business that generates good returns and growth over time. The group has various businesses like manufacturing spray nozzles for perfume models. Another business is plastic closures for household products. And then the last part of the business is that they make spray nozzles for pharmaceutical applications. The reason that last business is such a great business is that they work with the drug company to get approval from the FDA. Once the drug company gets approval from the FDA for the drug, Aptargroup’s spray nozzle is actually a key part of that application because it‘s counted on to deliver a consistent metered dose every time. This business actually generates 50% of the earnings for Aptargroup. We think there is a tremendous growth potential there. But last fall the stock fell from $45 to below $30 and the fear in the stock was that perfume sales would decline. Our belief was that a decline in perfume sales would be offset by good growth in the pharmaceutical side of the business. Then, we ran some downside analysis and looked at the worst case scenario where perfume sales fall off hard enough for earnings to fall 20%. Then we valued the company at 5.5x cash flow (defined as Earnings before Interest, Taxes, Depreciation, and Amortization), which is the lowend of its historical trading range. We did that and came up with a $25 stock price in a worst case scenario and the stock was around $30 at the time. We ran an upside scenario and assuming the company could grow earnings by about 10% to 12% over the next three to four years, put a medium multiple of seven times EBITDA and came up with north of $50 for our price target. The reason for having a seven times multiple was our assumption that the company could grow sales probably 6% to 8% and earnings 10% to 12%. The big earnings driver for them is the pharmaceutical business. We think there is a potential for double-digit growth over the next five years out of that business and it‘s over 50% of their earnings. The earnings potential is derived from new applications like some of the new vaccines that are coming out. Moreover, more drugs are being delivered through nasal spray. The theme is not necessarily new drugs per se, but a new way of delivering them. In our view, this is really a high quality company with almost no debt at least on a net basis. Until this year, the company never had a year-over-year decline in revenue and has a history of doing small but accretive acquisitions. Another stock that we really found value in for the next few years is Airgas, Inc, which distributes industrial, medical, and specialty gases, welding supplies, safety products, and tools online through over 700 locations nationwide. They actually own the containers and lease them out to their customers and charge a fee. In this way, whenever the exchanger is empty, they just come out and refill it to provide more gas. We estimate the company is generating $400 million of cash flow per year just from leasing their cylinders across the U.S. Airgas has a local business model with enough density built in the market and an effective distribution that generates some pretty attractive economies of scale. They‘ve done a lot of acquisitions in the past twenty years to build up the business to the size that it is today. Their annual sales were just over $4 billion. The EBITDA margins are in the mid-teens, and we think eventually can go up maybe up to 20%. Really there‘s a lot of room for accretion here. The company has had earnings per share of just over $3 in the past twelve months by cutting enough costs. And over time there‘s potential for the earnings to go to $5 and $6 earnings driven by operating leverage to base volume growth as well as above average growth in new areas of focus like CO2 and refrigerants. But we think the real potential over time is acquisitions. The company has a history of doing accretive deals and we think they are going to do more deals going forward. Airgas also has strong pricing power. The reason is on the packaged gas side they have actually bought up some of their competitors that sell the raw material gas. This provides a strong competitive advantage on the cost side. But fluctuations in price won’t really affect Airgas‘s margins. They have had a very high renewal rate. The real cash flow of this business actually comes from the renewal of the containers. And part of the reason we bought this stock was earlier this year it was priced below $40 a share. So when the stock is below $40 it is almost a 12% yield on the estimated cash flow generated from leasing the cylinders. The real growth for Airgas going forward will be establishing new markets where they can build density and penetrating in markets they don‘t already have density in because that’s where their earnings growth comes from. Again it‘s real value in having density within that distribution model. Q:  How do you construct your portfolio? A : We employ a bottom-up fundamental research to select common stocks that we believe are currently undervalued in the market and can add value to the portfolio. The fund invests in approximately 45 to 65 securities, which are well diversified among market sectors. The fund pursues a “value style” of investing by focusing on companies whose stocks appear undervalued in light of factors such as the company‘s earnings, book value, revenues or cash flow. We are looking to construct a portfolio with the best ideas coming up from the analysts and also making sure that we are diversified. We are not interested in matching the index but making sure that we are not exposing our clients too much to any one earnings risk factor. There are three steps to our portfolio construction process. The first step is stock picking and the second step is the group review. Then the third step is refining the ideas flowing up from the analyst that have been reviewed. Once they are approved they go into a list call as the “On Deck Circle”. What we are looking for here is to build up a pool of 10 to 15 stocks for each portfolio. These are stocks that have been reviewed and meet risk/reward characteristics and are ready to go in the portfolio. The most important aspect of our portfolio construction is that we have a very strict discipline when it comes to selling stocks. There are some triggers for selling a stock, including the following - securities reaching a predetermined price target, fundamental change in company or industry that negatively impacts original investment thesis, and changes to a company‘s fundamentals that make the risk/reward profile unattractive. Q:  How you do mitigate risks perceived in the portfolio? A : We have a concentrated portfolio of 45 to 65 securities that mitigates risk. We focus on picking stocks at the right price with an asymmetric reward risk. This is another risk control measure. There are a couple of things that we‘ll do at the portfolio level to control risk. We focus on limiting downside risk and will purchase a security only if there exists a 3-to-1 ratio between upside and downside potential over a three-year period. The other rule is that we will not let any one sector go over 25% of the portfolio. We also run target weight positions. Most positions are going to be 2% of our fund but we are going to trim it back as it hits 2.5%, as it has some of the highest risk in the portfolio. And conversely, if the stock drifts from 2% to 1.5% weight, it’s kind of underweight and underperformed and emotionally we may not like it as much, so at that point it forces us to make one or two decisions namely of either selling the stock entirely or buy it underweight back up to 2%. The key to managing risk at the portfolio level is a strict discipline when it comes to selling stocks.