Q:  What is the history and objective of the fund? A : The Value Line Income and Growth Fund was launched on October 1, 1952 and currently manages $305 million in assets. I have been managing the fund since June 2011. The fund’s primary investment objective is to generate maximum and sustainable income with moderate risk while providing additional return with capital growth. Presently, the firm has $2 billion of total assets under management spread over a family of 10 9 no-load funds. Q:  What core beliefs guide your investment philosophy? A : The primary focus of the fund is to create income with an appropriate amount of risk. This principle guides us to the capital structure of the company that provides us with the best risk reward ratio. Q:  How do you transform your philosophy into a consistent investment strategy? A : At the minimum, we will be at least 50% invested in stocks in this fund, with the balance of the assets primarily invested in U.S. government bonds, investment grade debt securities, and convertible bonds. Our asset allocation decisions are based on the attractiveness of the asset classes. In our stock investments, we emphasize large cap companies with healthy balance sheets and paying dividends that are growing. We generally have a preference for companies that are trading at a higher-than-market dividend yield. In our fixed income investment allocation we favor high quality corporate and U.S. Treasury securities. We continue to emphasize investment opportunities that afford reasonable valuation levels, healthy balance sheets, income generation, and positive cash flows. We invest ideally at or above market yield in companies with a strong balance sheet, a low payout ratio with free cash flow yield that exceeds their peers, and a history of raising the dividend. There are a number of stocks in the portfolio whose dividends have been raised by 20% every year over the last couple of years. Q:  What is your asset allocation process? A : I would say we tend to be more bottom-up driven. As far as management responsibilities are concerned, Liane Rosenberg, co-portfolio manager, runs the fixed income portion. If I find a reasonably priced stock trading at a good yield with healthy financials and the ability to grow dividend going forward, I will prefer to invest in the stock than in the bond of the company. Being cognizant of valuation, we will always evaluate the relative merits of investing in debt or stock of the company. As of this moment, we see more opportunities in stocks, which consequently leads us towards a lower allocation to fixed income and a higher allocation to stock. And within fixed income, we have been lowering our allocation of corporate bonds. Even on the convertible side, we are not currently finding many attractive opportunities. Q:  How do you conduct your research process? A : Initially, we screen 1,300 companies for higher-than-market yield as well as lower-than-market payout ratio and free cash flow before we overlay all that with valuation. We also take advantage of our Value Line Timeliness Ranking system that has been developed over several decades. The fund’s investments are principally selected from common stocks ranked 1, 2 or 3 by the Ranking System based on a scale of 1 through 5. Then, we determine the percentage of the fund’s assets invested in each stock based on the stock’s relative attractiveness. Other metrics that we typically take into consideration are income opportunities. We are attracted to companies that are able to grow sales and earnings, and thereby have the wherewithal to increase dividends in the future. As part of our research efforts, we also concentrate on companies that are growing steadily in line with the product cycle. Not only is that generating free cash flow, but the stock is also trading at a reasonable price compared to its future growth prospect. At the time of the purchase of a name, we are generally looking to hold the stock between 12 and 18 months. During that holding period we participate in earnings call conferences and attend several industry events to keep abreast of any developments. To sum up, we look for companies with business models and earnings capacity, which in turn allows them to either buy back stocks or increase dividends. Q:  Could you illustrate your research process with a few examples? A : eBay Inc., the ecommerce company, is a perfect example of our research process. We bought eBay in the first half of 2012 because we thought there was a lot of embedded value in it and the company was still growing moderately. As the core marketplace business has slowed down considerably, its online payment platform is still growing rapidly. PayPal is the hidden gem there. With this stock, we were not only paying a reasonable 13 times earnings for a maturing business, but also paying almost nothing for the future growth prospects of PayPal. Growing at 20% to 25% a quarter, PayPal is going to be a bigger part of eBay in about two years. At the time of our purchase, eBay was out of favor and the stock had fallen off the radar of most investors. However, we thought that there was a lot of embedded value in the price of the stock and that the company was set for steady growth for several years ahead. Presently, our price target is in the high 50s and the stock is about $49. The bulk of our investment thesis is still intact and we are going to continue to own that stock. As far as other sectors are concerned, we own a lot of healthcare names, but the field is not without risks, so we are cautious. Not only do some of the drugs developed by the industry fail to live up to expectations, but, what is worse, some of them have been harmful to patients. What is more, the industry is battling competition from the generic drugs makers, and in the long run most companies have underperformed. For example, we bought Merck at 4.5% dividend yield. They are probably at 3.5% now, and their payout ratio is 24%. Another example would be Sanofi, which trades at a 3.5% yield and payout at 24% of its earnings in dividends. The company’s management has been increasing its dividend at 20% a year and for all that we were paying only 11 times earnings. That is certainly a good way to make money in the long term. One of the stocks that has done quite well for us this year is Gilead Sciences, Inc., a company with a dominant position in HIV treatment, which recently acquired Pharmasset, Inc, the maker of promising hepatitis treatment drug. The reason why I was attracted to the drug maker was its strong franchise generating reliable massive amount of cash flow that was visible for several years. That is, in fact, quite unusual for a cyclical company. With Gilead we feel confident what their cash flow is going to look like in five years from now, and by doing a discounted cash flow model, we determined that the stock was trading at a discount to its future value. At the same time, we are lowering our exposure to the utility sector because we are not optimistic about the future dividend growth and the prospect of higher payout ratios. The yield on utilities is higher right now, but there are utilities yielding 3.5% and their payout ratio is anywhere from 60% to 85%. Moreover, utilities are not going out of their way to raise their dividend. Most of the companies have large capital spending programs and negative free cash flow. Buying for 17 times earnings, which is a high price-to-earnings multiple on a utility, is such a mismatch that we have been lowering our weighting. Having said that, there are a couple of names in that space that we like, but they seem to be exceptions in our view. From a fundamental basis standpoint, we do not overweight the portfolio with utility names. Q:  What is your sell discipline? A : We have a price target for every single company. When a stock reaches our established price target, we sell. In addition, we also have a downside target for every company. In general, we look to sell the company if the stock falls 15% below our purchase price. Even though we do not have a hard rule, we review our position and the thesis why we bought the company in the first place, and if we cannot justify the reasons, we resort to selling. Q:  How do you do your asset allocation on the fixed income side? A : As a whole, the process of allocating capital on the fixed income side is similar to the allocation on the equity side. We are looking at the credit spreads for each class of securities and what kind of risks we are required to take. Because of the yield curve direction in the last five years, we have been looking more and more at securities issued by the government agencies and mortgage securities. We still own some corporate bonds, but not as much as we used to, because we do not see the returns warranting this risk. Our allocation between the sovereign agency and the corporate bonds is driven entirely by our bottom-up process. We do not completely avoid the U.S. Treasuries because there is a stabilizing element on the Treasury side to the fund, and, once again, the overall outlook for the fund is a moderate amount of risk. Q:  How do you build your portfolio? A : Typically, the portfolio would comprise anywhere between 100 and 150 stocks, as we try to stay widely diversified with no more than plus or minus 50% in any sector versus the S&P 500 Index. An individual position in the portfolio will not exceed 5%. In the last ten years, our allocation to stocks has been as low as 50% in the fund and 70% on the high side. The low end on the fixed income side has been probably about 20% and the high end has been around 40%. At the same time, convertible bonds have been anywhere from 0% to 10% and cash as much as 20% respectively. Currently, we have 28% to 29% of the portfolio invested in fixed income and about 4% to 5% allocated in convertible bonds. Our allocation to cash is currently quite low, at about 3%, as we are finding more income opportunities on the stock side, which accounts for 64% of the portfolio. Q:  How do you control risk? A : First of all, we are a well-diversified fund which holds sovereign bonds in addition to stocks to stay protected from frequent market meltdowns. Our research process also guides us towards companies with strong balance sheets and stable businesses, which ultimately helps us to control risks. Furthermore, we have access to various third-party tools that enable us to determine sources of risk.