Q:  Would you describe your investment philosophy? What’s your way of managing money? A : Dividends are the key aspect of our philosophy and every stock in our portfolio pays a dividend. The other important aspects are valuation and fundamentals. We buy stocks only when all the three aspects are aligned, and we sell stocks if any of them is violated. Dividends are crucial because they provide an important source of total return with lower volatility. The positive effect on total return can be proven empirically by historic comparisons of the reinvested total return over time with or without dividends. Regarding the volatility, when a company commits to paying a dividend over a long period of time, it sends an important signal to the marketplace. Management is loathe to cut a dividend, so such a commitment indicates how they feel about the health of their business model. In addition, dividends promote financial transparency and discipline. Q:  How does that philosophy translate into an investment strategy? A : We are traditional value managers looking for undervalued stocks. We focus on fundamental research and we build our portfolios bottom-up, on a company-bycompany basis. We dig into balance sheets, cash flow statements, and income statements, trying to identify the fundamental catalyst that will drive the stock price higher over the next 12 to 24 months. The catalysts can be numerous, ranging from acquisitions to divestitures, new product rollouts, or management changes. Q:  Are you a value manager or a deep value manager? A : We are not deep value investors. We are just looking for stocks with low expectations, or stocks that might have short-term problems. If our fundamental work indicates that these problems can be cured, we are willing to get into the stock, especially when there are improving fundamentals and catalysts. To me, deep value investing means undertaking a tremendous amount of risk. The downside potential often is 100% because these companies can go bankrupt. That’s not something that we would like to do. We are looking for companies with intrinsic value that we believe will be realized over the next 12 to 24 months. Q:  Could you explain your research process in terms of finding investment ideas and turning them into holdings? A : We start with proprietary models that screen for dividends and valuation. That narrows down the uninverse to dividend-paying stocks that trade in the lower third of their historical range. Then we dig on fundamental basis, looking at balance sheets, income statements and cash flows. We have a team of six analysts, each with sector responsibilities. They do traditional fundamental analysis that aims to evaluate if the dividend is sustainable through varying business and economic cycles, and to identify the fundamental catalyst. The analysts work closely with the portfolio managers and that work includes talking to managers, competitors, suppliers, Wall Street analysts, attending industry conferences, etc. That fundamental company-bycompany research aims to understand the business model and to identify the catalyst that will take place over the next 12 to 24 months. There could be numerous catalysts, including a new product rollout that the market is not understanding, an acquisition, management changes, or just the improving economic cycle. Q:  How many stocks in the US pay a dividend? Do you look for companies with growing dividends? A : This is a mid-cap value fund, and the mid-cap value dividend-paying stocks are probably around 1,000. After our initial proprietary screening, that universe is narrowed down to about 500 stocks that are worth looking at. The important part is that these companies have a history of paying dividends through varying economic cycles. I am attracted to companies that raise their dividend, but that’s not a component of my screening. Q:  Despite the security that dividends provide, many investors were hit by the disasters in General Motors, Citigroup, or AIG. How can a manager protect investors from the hurricanes that sometimes sweep the market? A : I believe that the focus on dividends and the bottom-up financial research has helped us to avoid many of the disastrous financial stocks. There is no reason for the companies with problems to pay dividends; they cannot afford them in this environment. Paying dividends would mean paying out capital that they cannot regenerate, so we have managed to avoid many of the financial stocks before the big blow. It is an interesting fact that our performance over the last 12 months, three and five years has been very strong relative to the peers and the benchmark. Our fundamental research is crucial; we don’t buy companies just because they pay a dividend or have paid one. The analysis of the cash flow, the assumptions about different economic cycles, and the decision whether they will be able to pay the dividend through these cycles, represent important checks in the decision-making process. When a company has been able to pay the dividend through the cycle, you can be comfortable buying a bigger position in the stock when it gets lower. Q:  Could you give us some examples of specific stocks picks that illustrate your research process? A : Mattel, the world’s largest toy manufacturer, is a good example. Its dividend yield is about 5%, well above the average yield on the market and any bond proxy yield. The company is a cash flow machine, generating a tremendous amount of cash, and we are very comfortable owning it. The valuation is very compelling at 19 times earnings. The fundamental catalysts, which will drive the stock price higher, include some great new products and licensing for the products for the movie “The Dark Knight,” among other things. because of the dividend, the valuation, and the catalysts, I believe that Mattel can make it through the recession, although nobody can predict the depth or the duration of the current recession. We expect Mattel to continue paying the dividend yield and, due to the strong catalysts, we expect the stock to continue doing well relative to the market in this environment. Another example of a company that we really like is People’s United Financial, a Northeastern thrift. It has a strong excess capital position and doesn’t need to go to the U.S. government for help. The credit quality in its portfolio is strong; the dividend yield is 3.5%; its valuation and fundamentals are compelling. On a priceto- book basis, the company trades at 1.5 times. The fundamental catalyst is pretty incredible; the company has $2.5 billion in excess capital that it will invest at the bottom of the cycle. So, that bank will be able to grow at the bottom of the cycle, when all the other banks are shrinking. Due to the combination of those factors, People’s United became the largest holding in our portfolio. It is a financial company that is not likely to cut its dividend. Actually, it is growing the dividend in this environment as opposed to going to the US government for help. Overall, there are stocks in many different sectors that we really like even in these difficult times. Q:  What is your portfolio construction process? A : We build a well-diversified portfolio of 60 to 80 stocks that we typically hold for 12 to 24 months. Although we don’t manage to a benchmark, we are very cognizant of our benchmark, and we are constantly monitoring the portfolio for risk and reward. We build the portfolio in a bottom-up, company-by-company process. Most often we start with 1% positions. The size of any position cannot be greater than 5% at cost. Typically, we buy up to 3% in any stock. As long as the catalysts for owning the stock are there, we would own it for the long term. We do trade around positions. If a stock gets cheaper and the fundamentals are still there, we may buy a bit bigger position. We don’t have any limits on sector exposure; I believe that such limits are handcuffs. Instead, we let our process guide our sector exposure. In other words, it is the screening and the company-bycompany selection process that determines our overweights and underweights, not the benchmark. When the energy stocks screen as really cheap dividend payers with solid fundamentals, we want to have the ability to overweight them significantly. Q:  What is your view on risk? How do you measure and control it? A : Our proprietary dividend screen is our primary risk control. The fact that dividendpaying stocks have lower volatility can be proven empirically; there is numerous data to back that up. The other important part of risk control is the rigorous application of our process. All the three factors - dividend, valuation, and fundamentals - should come together to buy a stock, but we would sell whenever any of them is violated. If the dividend is eliminated, the stock is sold. If the valuation doesn’t make sense any more, or if we were wrong on the fundamentals, we would sell the stock. So, it takes all the three factors to get in the portfolio, and only one of them to get out. Our process is all about risk versus return. Another risk-control measure is the diversification. With 60 to 80 stocks, we’re always well-diversified among and within sectors. It would be a very rare situation to have zero weight in a sector; it doesn’t happen often, if at all. We are constantly diversified among and within sectors. Q:  In certain periods, the ability to pay dividends can be jeopardized. Do you spend time researching what could drive the dividend away? A : Absolutely. The major focus of our fundamental research is making sure that the companies have the ability to pay the dividend in varying economic cycles. One of the first things we do is looking at the dividend policy and the company’s history. If a company is paying a dividend, it is important how committed the management team is to the dividend. It is also crucial if they have the cash flow to pay the dividend and should they be paying the dividend. That’s part of our analysis. I believe that a process that aims at avoiding the disasters is crucial for any value manager, and that’s the key reason for our performance. While most value managers aim to own the stock that will be the big winner and will outperform the market over a period of time, not all of them understand that avoiding the traps and disasters is even more important. That understanding is a key part of our fundamental process and risk control.