Q:  How has the GMG Defensive Beta Fund evolved? A : The investment landscape around 2007 and prior to that presented the investor public with little choice of instruments such as Exchange Traded Funds and notes offering exposures to commodities, currencies or emerging market debt. While these instruments are more accessible and available today, they were simply not around at the time. It was very difficult to implement investment strategies for individual investors. That was why we set up Montebello Partners, LLC, the investment advisor to the fund, to address those needs and opportunities. The company wanted to offer a mutual fund that not only had its core investments in large cap stocks, but also provided an overlay of commodities, currencies and risk management tools that were not available to individual investors. The GMG Defensive Beta Fund, which was launched on August 14, 2009, is a fully diversified fund that can invest in commodities, equities and currencies with the mandate to go long or short. William Krivicich is the lead portfolio manager, while Richard T. Kersting, Gary M. Goldberg and I all serve as co-portfolio managers. Q:  What are the underlying principles of your investment philosophy? A : We do not believe in taking high investment risks and leveraging funds to generate potential high returns for most investors. Instead, we prefer to take a defensive approach by having a broad basket of stocks to limit volatility while still participating in the growth of these companies. Our measured approach is designed to protect our clients’ principal as much as it grows it. Q:  Could you briefly explain your “alpha variance” process? A : We have developed our “alpha variance” process that basically addresses the three steps of investing: where, when and what. We start with a global asset allocation, a traditional top down approach to investing, with a subsequent tactical overlay that helps us determine when to invest as well as what to invest in. This technical analysis also helps us determine when to add or reduce various positions. The first step in the process is where to invest. Here, we focus on the regions and markets around the world. Where we decide to invest is driven by our views on the evolving global macroeconomic scenario and where investment themes take us, which may be driven by the demographic or consumer spending or commodities cycle. The second step revolves around what to invest in. Once we decide where we want to invest, we focus in selecting securities, stocks or bonds or commodities. Our fundamental investment approach helps us in selecting securities based on valuation and growth criteria that we prefer. Our selection of stocks is driven by the long-term viability of a business model and our views on the earnings growth sustainability. In the end, after we have selected stocks we like to invest for the long term, it is time for us to consider the timing when to enter the market. As part of our process, the timing of the purchase is no less important than the selection of stocks. We generally look at granular metrics like market momentum and how investors view a specific stock. Our “alpha variance” process is defensive and designed to help limit losses rather than simply capture gains. We hope that our process will help capture most of the upside and avoid most of the downside. Q:  What is your investment process? A : The first step is to build a global asset allocation. We have top-down considerations with macro analysis, sector analysis, thematic projections and then general risk management overlays that we utilize. We do not want to have more than 25% in any one sector or asset class. The second step to that is the bottom-up consideration. On the equity side, we focus on the strength of the balance sheet. Generally speaking, we search for companies that have a well-diversified business and multiple revenue streams, profit margins and exposure to emerging markets in Asia and Latin America. Additionally, we prefer companies whose operating and net margins are leading the industry. At the same time we tend to avoid companies that are capturing market share or growing by dropping the price or margins. In our view, such a course of action could lead to the destruction of the business model. On the fixed income side, we look at credit analysis, bond duration and apply standard analysis in selecting securities from companies that have the balance sheet to repay the debt. We also look at correlation and how all these different investments in asset classes react to each other. After we have selected the regions, sectors and stocks, we will apply appropriate weights to each sector and each holding. We prefer stocks that have sustainable growth in earnings and revenues and our intention is to hold them for several years. Our defensive approach helps us not only in selecting companies but also deciding the timing of purchase based on our technical analysis. Q:  What drives your bullish approach? A : We differentiate between long and short term. For example, in early November we were still bullish on equities and felt there was a fair amount of upside because we thought that markets had overpriced the risk of a global recession on a slowdown in China. But on the same token, the technical factors that we are monitoring indicated that the market was heading to a pause and somewhat of a pullback. So, we did not commit additional capital through new assets coming in and remained overweight in cash. It is a bit of a trade-off to make sure that we stay invested instead of turning into a market timer and that we keep a watchful eye on technical indicators to reduce overall portfolio risk. Currently, we are overweight in the U.S. large cap multinationals but we are now starting to see more value in the stocks of the European multinationals. We are bullish on base metals and energy and remain a little less bullish on agriculture. But if we were to add to agriculture, it would probably be coffee, wheat and sugar as opposed to corn or soybeans. Q:  How do you do your asset allocation? A : Our normal asset allocation would be 60% equities, 25% commodities, 5% currency, 5% option and 5% fixed income and cash. We do not bet on currency moves but prefer to have indirect exposure to currency currents that are generated by the economic cycles or interest rate policy. The option strategies that we utilize are mostly buy-write strategies, so we write short-term profit calls and roll those that work particularly well in a down and flat market. As far as fixed income and cash are concerned, we focus mostly on full term fixed income. There is not much of an incentive in this environment to buy corporate or Treasury bonds. But given the yield and expected return on a forward basis compared to equities, particularly high dividend paying stocks, we favor the latter. We set the asset allocation based on our view of the world and our approach is a very much global macro. We are agnostic in terms of where we invest. In other words, we look across the globe and various asset classes to determine where we believe the appropriate opportunities are. The technical information that is currently available is another determining factor as to how much exposure we want in any asset class. Q:  Historically, what is the level of equities that you prefer? A : We would certainly be willing to go to zero equity exposure, or zero commodity exposure, or 100% cash if there is a breakdown in the market. In the past we have dropped our equity exposure to 40% with about 30% cash, but that is very unusual. Generally, we try to find opportunities to invest, our intent is not to have large long-term cash positions. Our new additions to stocks are guided by technical conditions in the market. We look at the technical parameters of the market and those of a specific stock that we may be considering. If that analysis suggests that the stock is in a sell mode, we are prepared to wait till it regains favor with investors. Still, from a risk management perspective in protecting the capital, we would want to see a confirmed uptrend based on volume, price momentum data before committing new capital. Q:  Would you elaborate on your process with some examples? A : One of our favorite stocks is Cliffs Natural Resources Inc., an international mining and natural resources company that operates in many countries. Thematically, the stock fits well into the niche of global and infrastructure expansion. Additionally, they are growing their business internationally, in particular by gaining market share in Asia. Moreover, the revenues that they are generating are accretive to their earnings as a whole, meaning that it is a high profit margin business compared to their overall business. Also, their profit margin is in the 28% range compared to the industry average of 18%. Additionally, their price-to-earnings ratio, price-to-book, and price-to-sales are all very low. This is a stock that certainly fits in our global investment theme and meets the fundamental requirements that we are looking for. Nevertheless, we added very little to Cliffs Natural Resources over the summer months because, when looking at the volume and the technical data, the stock was getting demolished. Consequently, we waited and started adding to it in the high $50s. Another example is International Business Machines Corporation, the leader in IT services provider and our top holding. Here is a stock that has been on the continuous upside since it began its advance in the low $100s. We started buying it in the $110 range and have continuously added to it because it has not had any technical breakdowns. We are fully weighted on that stock. We do not want to go overweight and become concentrated in this position. Teva Pharmaceuticals Industries Ltd., the generic drugs maker, has been the favorite of investors for years as it expanded its product portfolio and built a process to leverage generic market for drugs that were coming off the patent protection. After being a great performer for two decades, Teva continues to execute on its overall strategy fairly well. About a year ago, it started breaking down technically and the volume on the sell side was significantly heavier than the volume on the buy side. As a result, we started selling gradually. This is an example of how the market technicals told us to get out as heavier volume was on the downside. Q:  How do you select your investment themes? A : Between the four of us on the portfolio management team, our chief investment officer is the person who is ultimately responsible for making the decisions, but we all have specific responsibilities on certain groups of securities and sectors. For instance, I am focused on international securities as well as currency. Richard T. Kersting looks at the technology companies that we own including Google, IBM and others, as well as our small cap exposure that is generally technology focused. Gary M. Goldberg is on the U.S. equity large cap side, and William Krivicich, our Chief Investment Officer, focuses on everything and makes sure that the risk parameters are observed. Q:  How do you build your portfolio? A : We try to have between 40 and 60 stocks while trying to maintain broad-based exposure to commodities in the agriculture, metals and energy sectors. Our portfolio turnover in 2011 has been about 30%, which is very low compared to our peers. We invest mostly in individual securities and round out the portfolio with exchange-traded funds and exchange-traded notes and we do not want to have more than 25% in any one sector or asset class. Q:  When do you re-examine a stock? A : Volatility certainly plays a key role in that decision. If a stock or an investment falls by more than 8% of its initial purchase price or by more than 15% of its 52-week high, on a beta adjusted basis, we will re-examine the position. We do not necessarily sell it by default. Q:  What kinds of risk do you focus on? How do you manage risk in the portfolio? A : We manage volatility regardless of the nature of our holdings. Our defensive approach in selecting stocks and allocating capital to a specific holding helps us in managing downside volatility. Since our investments are managed on a rules based process, we are quite disciplined in how we select stocks and how we allocate capital. We pay a lot of attention to market and individual stock related technical parameters. To sum up, our defensive approach to investing complements our fundamentals-based stock selection as we seek long-term earnings growth.