Q:  What is the history of the company and the fund? A : We launched mid cap investing strategy over 10 years ago and we managed in a traditional fundamentally-oriented mid cap value approach from 2001 to 2006. In 2006, the firm decided to transition this strategy, as well as our mid cap growth strategy, to our quantitative team. We call this a blended research approach, which takes some of our fundamental inputs and combines them with our quantitative inputs to come up with scores on stocks that score highly under both the quantitative and the fundamental process. At the end of 2008, the firm made the decision to bring both the mid cap value and mid cap growth strategies back to the fundamental side. We found that under the quantitative approach our analyst team was lacking a vehicle, or a portfolio, to implement fundamentally-oriented investment ideas. In addition, we thought we could drive deeper discussions in the mid cap space by actually having a team dedicated to the space to help push the analysts and help them continue to uncover opportunities in the mid cap value space. We manage about $1.7 billion in the mid cap value strategy, with about $1.3 billion in the mutual fund structure. What is interesting about our strategy is our overall idea generation among a dedicated team of small and mid cap analysts and our global team of sector analysts, giving us a bigger pool of stocks from which to select. As a result, we have a greater competitive advantage, as long as we execute. Kevin also works on our small cap value strategy. Brooks is a mid cap value manager on this product and also works on a large cap value strategy. To have fund managers with experience in managing a large cap fund, a small cap fund and practicing value strategy, working together, is unique. MFS has a good integrated research process. Kevin is one of our directors of research and Brooks runs global recruiting. We think we share ideas better than any of our competitive peer firms. We not only do our own work sourcing ideas and using our global analyst pool, which is pretty common, but we have also been helped out by a lot of our fellow fund managers. For example, we have the number one utility manager in the United States, Maura Shaughnessy, who sits right next to us. We take note when she, or other managers, are buying mid cap value stocks for their portfolios. Our international exposure, while it is never a huge percentage of the fund, has had some great, unique ideas that were generated through collaboration with our colleagues working in eight offices around the globe. Our fixed income department also provides us with ideas in the mid cap category. For example, CIT Group Inc, the asset lender, and Delphi Automotive, the auto parts maker are companies that have emerged from bankruptcy recently. We had a competitive advantage because our fixed income team had already done a lot of work on these companies. We have a dedicated SMID (small and mid cap) research analyst team with members dedicated to following: healthcare, energy, business services, industrials, technology, and REITs; and we also have SMID analysts internationally. For the last 18 years Kevin has covered utilities, telecom, technology, and with MFS he has covered utilities again. For the last four or five years he has been an analyst covering financial services. His coverage includes a big piece of the index. Brooks has been at MFS for 17 years and for the first five of those he was covering the non-bank financials, such as credit card companies, home equity lenders, and investment banks. He also covered the casinos, hotels, airlines, and enterprise software. For the last nine years he has worked on large cap value strategy. Brooks has worked on this strategy in the mid cap value space for the last five years. MFS, founded in 1924 as the first open-end mutual fund, today manages more than $360 billion for individuals and institutions around the world. The firm has more than 200 investment professionals in nine locations worldwide. Q:  What is your investment philosophy? A : When you look at the types of companies we like to invest in, the core are companies with durable, long-term franchises. At any given time that makes up about 60% to 70% of the fund, we would like it to be 100% but it is a challenge to find great franchises that trade in the valuation range we like. We look for stocks with room for improvement but where investor expectations are low. These are decent businesses where multiples are low for a variety of reasons and we think there is opportunity going forward. In general we do not like to take huge sector bets. We do not like to take big macro bets or big market directional bets. We are trying to make this a stock pickers fund where we are doing bottom up analysis to add alpha. We also do not have huge individual stock bets. We will not have 200, 300, or 400 basis point positions in the fund. We tend to own a decent number of names. We are not going to bet the farm on any one sector, or macro call, or any one stock. We only want it to be driven by the research process and our bottom up approach. We also do what we call “gardening.” We like to get ideas from every single sector of our domestic analysts. Sometimes we will take small positions in those ideas. The reasons are that it may be way too aggressive growth company for us but if the analyst loves it and it is their favorite idea then we might take a growth company. It would not necessarily be value, and it would be a very small position. We may also take a small position in a name that we like where one of our analysts has done some work on the company but we feel the name warrants more research. We'll reassess after three months to see if a larger position is appropriate after seeing the additional research from our analysts. We meet with all our quant team twice a year for our risk review. When we met with them in 2009 one of the things they pointed out to us, versus our peers, was that we had a very negative bet on technology. We had to ask ourselves "was that a bet we felt comfortable with?" We do not know enough the technology sector to know whether or not it is going to be an outperformer or an underperformer, so we went to our technology analysts and we asked them to give us more tech ideas. It turns out those were some of the best stocks we have had in the fund. Q:  What is your investment strategy and process? A : There is a lot of sleeve rolling up. We go to a lot of conferences. We see a lot of companies in-house. We go to all of the sector meetings. What ends up happening is that we will do a lot of work on a company ourselves. We meet with the management team or read the transcripts on the conference calls and then bring it to our industry experts, our analysts, to poke holes in it. We have known each other for much longer than we have been working on the fund. We operate from a position of trust. If one of us has done a significant amount of work on a name with one of our analysts, and feels good about the name, we will generally have a quick conversation with the other as to why we think it is a good idea to put it in the fund. The other person, 95% of the time, says that if you have done the work, you have worked with an analyst, and you think it is a good idea to put it in the fund, we should go for it. We will typically do not debate stocks if one of us has done the work. Having the people and the intelligence is important but if the ideas do not get communicated it is a waste of time. We have an offsite for the entire research department from all of our different locations around the world to meet in one area. We have a lot of sector meetings and investing meetings. We have a lot of dinners and lunches together. It builds a sense of camaraderie. Q:  What is your research process and how do you look for opportunities? A : We get a lot of ideas from sector meetings. Every single sector meets every week and it is a combination of the international analysts dialing in, the domestic analysts and the fixed income analysts getting into a room to talk about the best ideas in that particular sector. It is not always talking about small and mid cap stocks but also a lot of the industry trends that are going on with the larger cap stocks. It is a great way of sharing ideas and information. By way of example, Charter International is a company that we owned in the fund. We were meeting with a company called Lincoln Electric with our industrials analyst. He told us to meet with the company because they were a great business. We met with them and almost immediately felt that this was a duopoly. Lincoln has Brazil but Charter has Argentina. Lincoln has the United States but Charter has Europe. We looked up Charter and they were every bit as good a company but trading significantly cheaper because of the weakness in Europe. We talked to our domestic analyst about Charter and he said he had never even looked at them, much less done a full analysis. We called up the European SMID portfolio manager. He had not heard of the company so he called them up and got our European industrials analyst on the call, we got on the call, together with our domestic industrials analyst who follows Lincoln. We grilled the management team for a good solid hour, put a model together, determination its valuation together, and decided it was a pretty good idea. We bought across multiple funds. In less than a year another company acquired it. This is an example of an idea that bubbled up from talking to a competitor and leveraging our European research effort in a meeting with them. Two companies that we worked with a lot as a large cap portfolio manager are FedEx and UPS. We always met with those companies, met with the management, and worked with our global analysts that really understood those companies. There is also a company called TNT Express that was another player in the market. We were used to getting insight into them from FedEx and UPS. You can get a lot of understanding from bigger companies regarding smaller companies. TNT is a holding that we owned because we found good perspective on them from FedEx and UPS. What attracted us to TNT was it was a very oligopolistic business with limited competitors. International freight is generally a good business. We believe that the economies around the world are going to continue to grow. We obviously could not own FedEx or UPS in a mid cap fund. Our European analysts covered this stock, the company came in-house, and they met with us and we felt we knew it as well as a lot of U.S. companies we follow. In contrast, DHL did not really have a scale advantage in the U.S. and they were trying to grow in markets where they really did not have a competitive advantage. TNT had a very strong positioning in Europe. They built up a strong positioning in Brazil and China. We felt this company would do great on its own and grow in those markets and continue to invest. We felt it may be a consolidation target for FedEx or UPS at some point. We rarely buy a stock for consolidation, and that was not the reason we bought TNT, but it offers us good downside protection. We thought the underlying assets were pretty good. Eventually UPS made a bid for TNT, the stock ran up a lot and we had to revisit the position. Subsequently UPS was not able to buy it, so part of our thesis – that this was a potential consolidation play – changed. We sold the stock in the middle of the merger. It is not a stock we currently own. We had already seen the Justice Department would not allow UPS to buy it, so our whole thesis on downside protection, which we felt was pretty critical to the thesis, was gone. Another example is conglomerates. When we deal with conglomerates such as United Technologies and we ask them what areas of their business are doing really well, they might tell us that aerospace is doing really well and give us the reasons. That allows us to work with our analysts and decide to dig down deeper in aerospace ideas. The beauty of the mid cap space is you are not going to get companies with multiple business lines generally, but you will get companies with very specific business lines that are very focused on executing. You can get good guidance from the bigger companies as to strong growth areas and that can translate into very good mid cap ideas. We are not sitting near computers every day running screens. We identify companies by visiting four to six companies every single day and reading our research notes, going to sector meetings and seeing what companies MFS has visited to see which are better than the existing names that we own in telecom, or cyclical, or staples, etc.. Another example is Schweitzer-Mauduit International Inc. They are quite unique because there are few sell side analysts who follow it. There is not a lot of information about them out there. It has about a $1 billion market cap. What attracted us to it, other than being underfollowed and off the radar, is that is has a great balance sheet. As of the most recent quarter they have net cash on the balance sheet. It is very cheap and they dominate their market. Schweitzer makes Low-Ignition Propensity cigarette paper. This is a cigarette paper that when you put your cigarette down, within a minute or two it will go out, so it does not burn all the way down to the filter. It puts itself out. There are only two companies in the world that do this. The other company licenses the technology from Schweitzer. It is an effective duopoly, if not monopoly. The penetration worldwide is about 30% of LIP. Once a country mandates it, basically all cigarettes in that country become LIP. You are just waiting one country at a time to convert to LIP. The U.S. and most of Europe has converted, but we still have 70% of the world that has not converted yet. The second thing they do is make recycled tobacco leaf. They are the only company in the world that is independent and makes recycled tobacco leaf. Some of the very large cigarette makers do it themselves but the small and medium ones do not have the scale or the technology to do it. The penetration of recycled tobacco leaf is increasing because it is cheaper and it is lower in nicotine. As people come a little bit more concerned about nicotine, or governments clamp down on the amount of nicotine in cigarettes, the penetration goes up and they essentially have a monopoly. China is a gigantic market with a joint venture, which should come online sometime in 2014. The third and a current example is CMS Energy. They are an electric utility and gas company based in Michigan. After working with our utility team we felt Michigan State had one of the best regulatory environments of any utility. In utilities the regulatory environment is absolutely critical. Most people wondered why we were interested in being in Detroit with the auto exposure, but that was where we really saw the opportunity. This company traded below its utility peers and yet the regulatory construct, i.e. their ability to earn a return on each dollar they invest in a very timely manner, was phenomenal. We also felt they had a lot of growth prospects going for them. Q:  What is your portfolio construction process? A : Portfolio turnover tends to be in the 50% range. The higher quality companies tend to be the longer-term holdings so there is less turnover within that part of the portfolio. Some of the low market expectations, or turnaround opportunities, tend to be a little more opportunistic and therefore have slightly higher levels of turnover. A couple of other key metrics, when you look at the profile of the portfolio relative to the benchmark and the peers, is that higher quality does tend to translate into a higher ROE, relative to both our benchmark and our peer group. That helps to validate the quality bias that we have within the portfolio. A couple of other metrics that can also be good differentiators relative to the broader peer group is downside protection. Given our quality bias, given the valuation discipline that we are employing, what we have seen over the last five years is very strong downside protection. Since we took over, the downside capture ratio is 87%, which places us in the lowest quintile of our peer group. When you combine that very good downside protection, lower beta, more standard deviation, with the strong performance that we have generated, it translates into strong risk adjusted performance. We try not to make huge sector bets and we try to have a quality focus in the companies that we own. That is reflected in the three year trailing ROE being much higher than our peers in the fund. Also by having the number of the names that we have and not taking huge bets on any one particular name. The turnover in the fund is about 50% and we average anywhere from 150 to 170 holdings. We peaked in the high 170s but we are slowly brining that number down. Q:  How do you define and manage risk? A : We really focus on the company specific risks. We generally look for some kind of downside protection, such as a healthy balance sheet, or in TNT, how they had a unique asset. We spend most of our time looking at the company risk metrics and then we use our risk management team. In general we have risk management meetings twice a year and we have got an entire quant department that does nothing but look at the various risks that we are taking. It is extremely complex but they will tell you that you have got a lot of risk for oil prices going up, or credit spreads widening, or your overweight momentum, or underweight earnings surprises. It is a lot of data. For example, one of the meetings we had when we first started out on the fund was saying that we were underweight in technology. Now, we do not always change the way the fund is structured because of these risk review meetings but they measure it a million different ways and there is a lot of inputs on exactly what the risks are we are taking that you would not necessarily think about when you are just focused on the company-specific risks. It is a combination of keeping an eye on the company-specific risks and then our quantitative department making sure that there is nothing that is underneath the water that we are not aware of. There is also a natural risk metric where we try not to have huge sector bets and we try not to have massive individual stock bets. The overriding theme is to make sure our stock picking guides the results. For example, not to be leveraged to gold prices going up, or interest rates going up, or the market going up, or anything like that. We really manage those risks to make sure that all the talent we have here shows through and does not get erased because oil goes from $100 to $50, for example.