Q:  What is the history of the company and the fund? A : Managers Investment Group is the U.S. distribution arm of Affiliated Managers Group. We have offices in Connecticut, Pennsylvania, and Illinois. We offer long-term investment strategies through our unique platform that includes a family of funds and separate accounts managed by a selection of Affiliated Managers Group’s (AMG) Affiliated investment boutiques and a series of open-architecture mutual funds. As a subsidiary of AMG, Managers Investment Group is uniquely positioned to provide access to well known institutional firms and exclusive boutiques. At the end of June 2013, Managers Funds had approximately $32 billion under management across the entire mutual fund platform. Cadence Capital Management has been sub-advisor to the Managers Cadence Emerging Companies Fund since its inception in 1993. Cadence has been managing growth equity portfolios for the past 25 years. We have always focused our investments on growth companies with attractive valuations. Today we are an employee-owned company managing not only the Emerging Companies Fund, which is focused on micro-cap stocks, but also strategies focused on small, mid, and large cap companies. Cadence manages just over $2.2 billion for about 57 accounts, including the Managers Funds. Q:  What is your investment philosophy? A : Our investment philosophy on micro cap is really an extension of small cap; micro cap is a subset of the decision to move away from large company stocks. The reason to do that is the long-term return benefits of the asset class justify the increased risks that one accepts in an asset-allocation framework. To move beyond small cap, the reality is that because of risk constraints or their size of assets under management, most managers are not able to effectively allocate enough of their portfolio to the bottom half of the Russell 2000, the largest component of micro cap. For that reason, there is an investment opportunity to generate out-sized returns by investing in these small, fast-growing companies before they are widely recognized by the broader investment community. We are sector agnostic. We go where the better investment opportunities are. Q:  What is your investment strategy and process? A : The market-cap range we generally consider are stocks that are under $500 million in market capitalization. Between $80 million and $500 million in market capitalization is the general sweet spot for what we would describe as micro cap. The Russell organization defines that as the bottom thousand stocks within the Russell 2000 index, plus the next 1000 companies in terms of capitalization. The vast majority (75% - 80%) of the market capitalization in the micro cap benchmark is in that target area. We seek stocks which have sell-side coverage by at least one analyst. This helps us avoid orphaned micro-cap stocks which we believe could be poor investments. Q:  What is your research process and how do you look for opportunities? A : We start by identifying the companies with characteristics we think are most important for investment success. We identify these stocks using our proprietary quantitative model. This step of our process narrows down a potential universe, which could be as many as 2,000 companies, to a starting universe of 600 – 700 companies. We then subject this universe to the criteria that we have defined internally: improving fundamentals as evidenced by rising earnings estimates, attractive quality characteristics such as high return on capital and high quality of earnings. Finally, we look to see if stocks meet the final piece of the valuation criteria, which can be expressed both on multiples of forward earnings and, in the rear view mirror, good multiples of cash flow. So, at this point in our process, we have identified attractive investment candidates. From the narrowed down subset of stocks that have the right attributes to be good investments, meaning they have good fundamental characteristics and reasonable valuation, we want to take it a step further and really understand the drivers of earnings growth and the complete investment picture before a stock can make its way into the portfolio. When evaluating a company’s prospective earnings growth, we think in terms of pace and duration – how fast are a company’s earnings growing and how long will it last? You will find that we invest in companies that fall in different places on that spectrum. Some companies have fast earnings growth but perhaps not long-lived; others, slower but steadier earnings profiles. It is important to understand that at the outset, which we think makes for good investment decisions and helps us understand when to exit a position. The fundamental work starts with financial analysis of the income statement, the balance sheet, and cash flows in order to understand the driver of earnings growth. Is it a revenue growth opportunity? If so, why – a new product? Is it about pricing where the supply/demand balance is tight? We are not exclusively investing in companies with strong top-line growth. Balance sheet and cash flow changes can also work to the benefit of earnings-per-share growth and the stock price performance. We consider qualitative considerations. How is the company positioned within its industry? What is going on in the industry? Is it consolidating? Is it dominated by a few big companies? What is the geographical mix? There are a lot of companies in the micro-cap universe that are exclusively domestically focused, which can be a good thing, but they still can be influenced by international and global economic factors. We want to understand risk factors that may not be apparent in the numbers. Are there contingent liabilities? Have there been changes in executive management? At times, risk factors such as these will cause us to decline investment. Lastly, we take a hard look at valuation. We put it all together and discuss it as a small group. If we decide to invest we start a position at 1% of the portfolio, which is essentially an equal weighted position. An example is Carrols Restaurant Group. When we started the position it was really a few businesses that were wrapped up together. There was a Burger King franchisee together with a couple of smaller concepts – Pollo Tropical and Taco Cabana. We saw good growth opportunities, strong unit growth, well positioned concepts in their markets, and fairly narrowly focused from a geographical standpoint, largely the southeast. Keep in mind, at the time there was a lot of skepticism about the health of the consumer and whether the consumer was going to eat out. Along the way, Carrols Restaurant Group spun out the two concepts into a new company called Fiesta Restaurant Group. Its independence highlighted its unit growth and same-store sales growth. We exited our investment in Carrols, and retained the position in Fiesta. Fiesta continued to post strong earnings results, and the stock appreciated. Earnings grew and the valuation expanded, partly due to the stock gaining more recognition, to the point where in June the earnings multiple on Fiesta Restaurant Group was around forty times earnings. It was our view at forty times earnings that the stock had less upside and we elected to sell. When we initially originated our position in Carrols Restaurant Group, the Burger King business was improving, which was the bigger part of the mix, and the two smaller units we thought were undiscovered and not fully reflected in the stock price. That certainly played out, as those companies ultimately became part of an independent company through the spin out. Another example is TASER International, Inc. This is a stock we continue to own. We started our position in September of last year. TASER is the Arizona based company that makes electronic control devices, such as the stun gun. It was a very volatile stock about 10 years ago. There was a lot of hype surrounding it. Then the stock went quiet for a long time, but it started to report better results and our quantitative model identified the stock as having some attractive attributes and reasonable valuation. At first look, we observed that the company was profitable, possessed a clean balance sheet, generated good cash flow, and during the last couple of years, it had bought back a lot of shares. That kicked in the second part of our process, our fundamental research. Upon taking a closer look, we discovered some interesting things going on. First, Taser was in the midst of a major upgrade cycle in its core product line. They were also doing some things from a financing standpoint to make it easier for the municipalities to purchase the product. Importantly, they were investing in a new product category which had been incurring losses. With revenues starting to kick in, the operating losses to fund this upstart business unit were diminishing. We thought they could move to a profit position as that business continued to grow. That business is an on-officer video product. It is a little wearable camera, and they also have a partnership with Oakley, where there are some glasses with the cameras right on the side of the eyeglasses. The officer begins to record video when the officer has an encounter with a suspect. There was some skepticism among many police officers as to whether this was a kind of Big Brother monitoring device but it has been well received since, in many cases, it protects police officers from false accusations. There is also a recurring revenue aspect to that business as they manage the data and video content that is generated by those cameras. Let us digress for a moment on biotech, which represents a meaningful part of the Russell Micro Cap Index, at approximately 13.5% of the Index. Micro-cap biotech companies have unique business and financial attributes. They typically are not profitable, are focused on targeted disease-related indications, and are exposed to outcomes that are frequently binary in nature. As exciting as they might be from a scientific perspective, we view them as lottery tickets, because as a class they have a negative expected return but investors are willing to pay their dollar for a chance at the $10 million payoff. By their very nature, the majority of these companies fail to make it through our screening criteria for successful investments. When they are successful, biotech companies can be very profitable portfolio decisions; but when they do not work out they can be very costly. In the long term, our persistent underweight to the industry has helped us, but in shorter periods it can be quite painful and cause performance differentials (such as the first-half of 2012 and the first quarter of this year). Q:  What is your portfolio construction process? A : We equally weight the portfolio. There are generally 100 or so stocks in the portfolio, so the target weighting is 1% in each stock. The equal-weighting decision reflects that we are betting on a basket of characteristics. While we diversify the stock-specific risks of individual companies, it is still a very active portfolio. While we are sector agnostic in terms of identifying stocks, we still end up very diversified by industry and sector. Generally, in the large growth sectors of technology, consumer discretionary, and healthcare excluding biotech, we have sizable weightings and are relatively diversified. You would not expect to find a lot of utilities or telecom stocks in our growth portfolio. As already discussed, biotech is a persistent underweight. We look at the Russell 2000 and Russell Micro Cap Indices because we are building portfolios from the bottom half of the Russell 2000, which also is the top half of the Russell Micro Cap. We do benchmark performance to the Russell Micro Cap Growth Index, but we share both indices with clients because of the way we build portfolios. Q:  How do you define and manage risk? A : Our view is that risk is market volatility, because whether a client is an institution, a pension fund using an advisor or a consultant to help them with asset allocation, or an individual allocating through the mutual fund, generally they are doing so in a framework of risk control through asset allocation to prevent absolute losses. Position size helps manage risk. Limiting position sizes to 2% allows for upside appreciation from 1% starting position sizes, but limits individual stock risk. The top ten holdings typically represent about 15% of the portfolio. Our strict sell discipline helps manage risk. We do have the valuation discipline, which helps to mitigate some of the volatility and downside risk. Our sell discipline generally starts with whether the investment thesis has changed. That can be manifested in companies with deteriorating fundamentals, declining expectations and negative surprises. Those are the negative reasons that would cause us to sell. Positive reasons to sell include: the investment thesis has played out, or valuations are no longer attractive relative to other investment alternatives.