Q: Can you tell us a little bit more about Polaris Global Value Fund. How did it evolve? Is it relatively young as a mutual fund? A: It is young as a mutual fund, but its history goes back to 1989, when I started up something called the Global Value Limited Partnership. It was originally a private placement. It was simply a way for us to try and consolidate some of the individual accounts we were managing at the time. They were kind of small. So what we did was form this limited partnership called the Global Value Limited Partnership. We ran it that way until 1997, when it just got too big for its private placement status. In private placement you can only take on 99 investors. We had quite outstanding results in 1997 and right through 1997 that brought in a lot of new business. So we were forced either to change its status to a mutual fund or stop accepting new business. So in May of 1998 we finished the conversion process and it became a publicly traded mutual fund. But its performance record actually goes back to 1989. Q: I couldn't help but notice in the prospectus that in 1998 you had your lowest annual return, and the next year – 1999 – you had your highest. What happened? A: It was the first half of 1998 when we first felt the market was strongly overvalued. You know, even in 1998, we had a couple of years of overperfomance over the total technology, media, and telecom sectors. So, the things that we were buying, people were selling in order to chase tech and telecom stocks. As a result it made us look kind of silly in 1998, but basically what was going on was we were following our strict value discipline, and that's why we underperformed in 1998 relative to the market. Any time you show a negative sign in front of your returns like we did in 1998, nobody is happy no matter how right you eventually wind up being. Clearly we were right. For us a good value is one that earns us a proper global cost of equity no matter where we invest in the world. And we call that the Polaris Global Cost of Equity. So, that's what we're trying to earn and that's how we define value, and we think it's the only way to define value. Q: Some people connect global investing with some sort of global trends. Let's take outsourcing, for instance. Why don't we have a lot of investing success stories from the places where things are being outsourced? A: How do you make money on that, is a good question. Frankly, one of the reasons we think that's true is that there is this collision course between Eastern capitalism and Western capitalism. In the West, if you just take a look at the different stakeholders in a company, more or less you have shareholders and then you have customers and employees, management, community, and so forth. For the most part shareholders are at the top of that list. In China, you have a lot of stakeholders as well. They also include things like the government, which controls most of the big companies. The army, the generals, the generals' brothers and cousins, the regional governments, the unions. And somewhere in that mix is the shareholder, but from our contacts with many of these companies, the shareholders are definitely not at the top of the list. Chinese companies don't generate a lot of free cash flow. They generate some cash flow, but it all gets absorbed by a lot of other stakeholders, before it gets to the shareholders. And it's not surprising in some sense, because of the culture, but it is also one reason why for the last five years the Chinese mutual funds have not made any money. That's true of a lot of other mutual funds [laughs], but on the other hand one should expect those Chinese mutual funds to make a lot of money, because that was the one area of growth in the world economy for the last five years, while everything else was slowing down. So why didn't they make money? We think it has a lot to do with corporate governance. You have a very good point and it's one that I can assure you every day we open up the office door is something that we're dealing with. Q: Another problem, probably, is the insufficient public information on the foreign companies, especially in places like the ones you mentioned. What is the worst deficit in terms of information? A: China probably tops the list on that, too. Because it is very difficult to get financial statements that really mean a whole lot. Japanese companies are getting better, but, again, you see the same problem in Japanese companies – a lack of free cash flow. It's getting better, but it's still not there. The unfortunate thing in Japan is that investors are so starved for companies that are good investments there, that they wind up bidding up the few companies that are good to ridiculous valuation levels, so we were not able to invest in them because of our discipline. I suppose, to be fair, you can't exclude the U.S. as being one of the poster-childs for bad corporate disclosure over the last few years. In some ways we are not very surprised about that, because we were looking at free cash flows and not earnings per share or estimates for earnings per share, or EBITDA, or these other multi-syllable bastardizations of free cash flow. So, we do see the U.S. is actually getting better. Japan, interestingly enough, is becoming more forthright, the country that has the most room for improvement that is actually going to come through, is Korea. We still have a lot of money invested in South Africa. We think it's a real overlooked area and the companies there on the whole have undergone a lot of restructuring for the purpose of delivering a better value to shareholders. Again, no country is without room for a lot of improvement, but we do think South Africa is probably a good country. Quite frankly, among the emerging countries, we think it probably should be the model other countries should follow in terms of adopting democracy, capitalism, creating value for shareholders. Q: There's a piece of common wisdom that investors in global markets should probably be more comfortable with fluctuations, right? A: I would disagree with that. If you look at the Beta statistics of global funds, they tend to be lower than one, which means that relative to the U.S. market, they fluctuate less than the U.S. market itself. So, if you invest in a global fund, you do so I think for the sole reason of trying to achieve the Holy Grail in the investment business, which is to try and get the same return but with a lower risk profile. Well-diversified global funds can deliver that and it's one of the reasons why people should invest overseas. Q: Is it the same game in 2003 for you as it was, say, in 1998? Do you find value in the same places? A: We still see some of the valuations be the same. For instance, some of the companies that hurt us in the third quarter of 1998 were the British homebuilders. We think they still represent excellent value, we still own them. Likewise, some of the U.S. financials, less-than-large-cap equities, although we now begin to see better valuations in large caps. So, we're trying to move the portfolio and we're actively moving the portfolio more into the large caps. Five years ago we were seeing tremendous overvaluation in the large caps and we were avoiding them. Now we're no longer avoiding them because we're finding better value. Now that we're seeing better value there, we simply pursue it. Q: Let's get more specific and talk stocks. What were your best plays, best picks, over the last year? A: Last year, 2002, we had maybe 60 companies or so, and we had five takeovers. Three of them were banks, we had a paper company, and a tile company. Another company came along, we just saw it was very undervalued and we bought it. It was Jefferson Smurfit, the paper company. That was taken private. Ipswich Bancshares was bought as well as Warren Bancorp, these were two smaller banks in the Northeast. Then Dal-Tile was bought by Mohawk Industries (MHK). We also had strong performance in South African equities. The healthcare companies in the U.S. did reasonably well, because they are one of the few industries that we see actually generating price increases. The other area that we've done reasonably well in over the last year was the paper companies, as well as other resource-based companies. We can't just have overexposure to real assets. We balance off by exposure to financial assets, but companies like Methanex (MEOH), which is a dominant producer of methanol, was helped partially by higher oil and gas prices, but also because the construction industry which methanol goes into produces a lot of things. Some of the end products include things like plywood and the housing boom in the U.S. fueled demand for things like that. So, everything from methanol to paper, to platinum and palladium, all those sectors we had exposure to last year, and they all had reasonably good years, and I think everybody would agree with it, in a fairly nasty economy and quite volatile at that. Q: Did you chase that gold rush in 2002? The "gold stocks"? A: They did very, very well, yes. Some of our competitors, Jean-Marie Eveillard, did have quite a good exposure to gold last year and did very well. We just prefer commodities that have some more stable long-term end demand for them. Like platinum and palladium for instance. We prefer them to gold, because so much of it is used in things like automotive catalytic converters. There's a strong case to be made that more catalytic converters should be used in the world to try to keep the air pollution down. China doesn't have it. So, there's tremendous growth there, while in the case of gold, you're basically depending on some speculative demand that keeps the price up. Q: Closer to home, again, you mentioned Northeast banks. You are there, aren't you? A: Yes, we have a fairly strong weighting in those banks, and we have had for quite a long time. We've been able to make a tremendous Alpha or a tremendous amount of money on these stocks. There are two reasons. One, a lot of these banks are former mutual organizations and when a mutual bank converts into a stock bank, there's a tremendous value play there. Peter Lynch popularized it, unfortunately, and it got a bit more difficult. The other reason that the banks tend to be inefficiently valued is the big banks have merged with each other. Whenever a big bank merges, they lose a bunch of customers. If a big bank loses 5% of its deposits, 5% is not necessarily a big deal for a big bank, but when that business falls into the hands of much smaller banks, actually that can produce quite strong earnings growth. That's the other reason. Q: Let me ask you about Banknorth (BNK), then. It bought some of the names you mentioned before. Do you still own it? A: Yes, we do like the company, we still own it. This is an example of a bank that has transformed itself from being a traditional thrift to a full-service financial organization. Not only making mortgage loans like they used to do, but providing everything from checking accounts, to credit cards, payroll services, investment products, insurance. We think that's the future of banking. Banks have been severely regulated and restricted in their ability to compete in the financial industry and consequently the investment firms have really dominated the investment business, the likes of Fidelity, Vanguard and so forth. But Banknorth is an example of a bank that's kind of turning the tide in that respect. And even if you look at the numbers, many companies that used to dominate the investment business – Paine Webber, Salomon Brothers, Smith Barney – those names have virtually disappeared. Most of them are now owned by banks. Banknorth used to be a small bank. Now, it's over $22 billion in size. It's a pretty good sized bank and bigger than most banks in most countries. And it's also in the heart of economic strength in the United States. In the Northeast, there's an awful lot of wealth here, a lot of financial strength. It's a fertile area for companies to offer financial services. Yes, it is regulated, it has got strong disclosure, good corporate governance, and it is very granular in the sense that no loan is ever going to hurt that bank, because it has many, many thousands and thousands of loans. The risk is very well controlled there, so it is quite well diversified. Q: Now, the talk about banks, and Banknorth very much included, is about the net interest margin pressure. How real is that, if you're still comfortable with it? A: It is very real. So that's the real question going forward, and there are really two questions – will the economy stay very weak and if it gets worse, ultimately that has to translate into more defaults on loans, and secondly, if the economy stays weak and rates go lower that could make the interest margins decline. But having said all that, we think there are worse risks to be taking in the equity markets right now than these banks. And of course you've got the money supply. The Fed is doing everything in its power to pump liquidity into the system. And not only the U.S. Fed is doing it, but almost every central bank in the world is pumping liquidity into the system at a massive rate. And ultimately that will probably generate some inflation, if it is not totally deflated away by this issue with deflation we were talking about earlier. So, it's kind of a push and pull right now in the global monetary system. Ultimately, we think it'll be solved. And banks do not depend only on their net interest margin, they have also other fees and charges, and investment products, and insurance, and that's growing. It's funny because a lot of these banks are generating a decent 5% to 10% earnings growth, which in this economy looks absolutely fantastic. Five years ago if you came up with a 5% or 10% earnings growth rate, everybody would short your stock and send it into the cellar. So, we think sometimes flowing steady is just fine. Q: So, what is your worst fear, then? What are the most significant problems globally, and what would you definitely hate to see in 2003 and 2004? A: Well, we still believe that this collision course between the Eastern and the Western capitalism is the biggest problem for investors. Not only for the next 12 to 24 months, but for the next three to five years, or maybe the next decade. Because if we really get into this nasty, competitive, down and dirty, economic competition, there is not going to be a lot of money left over for shareholders. It's the free cash flow to shareholders that ultimately drives stock prices. So, that's the one thing that we worry most about, but it's also the one thing that we think is the most important reason to consider a global fund, because it allows the portfolio manager to find some place in the world where things are going well.