Q:  How has the fund evolved since its inception?

A: In the late 1990s we had a small cap and a large cap value funds. We realized that we needed something to offer that met our clients’ liquidity and market cap criteria and we set up the mid-cap fund in 2001. I have been the portfolio manager since inception and I have been with the firm just over 18 years. The fund started out as all mutual funds start – small and we did not have massive distribution at the inception. At the end of 2008, we had under $300 million in the portfolio and today, roughly six years later, we have $5 billion in the portfolio. In the last six years we have seen tremendous asset growth, which is different from a lot of our competitors. The fund is different from its peers in that we start with dividends; we are not yield investors. That is where people get confused. We do not manage to a yield. We like the characteristics of dividend-paying stocks, which leads into our investment philosophy. We start with dividends; every stock in the portfolio pays a dividend. The characteristics of dividend paying stocks that we like are that dividend paying stocks are an important source of total return and that dividend paying stocks over time have had lower volatility. But the one thing about dividend paying stocks that we think most investors miss is that boards of directors and management teams are loathe to cut a dividend, so if they commit to paying a dividend and have paid one through varying economic cycles, we think that sends a very strong signal about how they feel about the health of their business model. Dividends put financial discipline, financial transparency and a level of financial sobriety on the management teams. Our process is straightforward and simple. We are stock pickers, so we pick good stocks and we do bottom up fundamental research. The stock must have three things to get into the portfolio: dividend, valuation and fundamentals.

Q:  Historically have you found that companies that pay dividends are good or do you prefer companies that pay rising dividends?

A: We love to see companies that grow their dividends greater than their earnings growth. That’s a very strong signal they are sending about how they feel about the health of their business model.

Q:  Are there certain sectors or industries where you see this is more prevalent in your experience, or are there certain companies that are just able to deliver a dividend regardless of the business cycle they are in?

A: It is a little bit of both. There are no sectors that we are kept out of because of the dividend policy and there is no heavy leaning into a sector because of it. We are able to find ideas in all sectors, so there have been no handcuffs on us because of the dividend policy. Historically, back in 1990s, before even the portfolio began trading, technology was an area that you could struggle to find dividends but we have not had that issue at all. Some of the highest yielding stocks in my portfolio are technology companies, so there is no sector bias driven by the dividend component in the portfolio.

Q:  You have chosen to be in the midcap segment. What is the range of the cap that you would consider falls into your midcap definition?

A: Mid cap is defined as the smallest 850 stocks in the Russell 1000, so right now that range is less than a billion dollar to up to as much as $30 billion. The only thing we use the benchmark to tell us is the market cap range of mid cap. Every year the benchmark gets reset in late June, so currently mid caps are in the $2 billion to $25 billion market cap range.

Q:  What is your definition of value?

A: We are traditional value managers so we are looking for low expectation stocks where we think expectations are just too low. We define low expectation as companies that are trading in the lower end of their historical valuation range. We use whatever metric the market uses to value a security so if revenues, margins and earnings are important to a stock’s valuation then Price-to-Earnings is the appropriate valuation metric. If the company’s historical PE is 10 to 20 then we are looking for companies that are trading in the lower end of that range. But you can’t always use PE because, if we’re trying to value a natural gas company or a real estate investment trust or something that doesn’t use PE, you’ve got to use whatever metric the market uses to value it.

Q:  So this is not a deep value, intrinsic value strategy where you look at the balance sheet and take out the debt?

A: No, that is not part of our strategy.

Q:  So what are the other metrics that you use other than PE to acquire the stocks?

A: It all depends on what stock you are looking at. If you are looking at a financial or insurance company a lot of times they are valued at price to book. If you are looking at a real estate investment trust they are valued on cap rates or yield. If you are looking at a commodity company then you’ve got to use net asset value. So there are different valuation metrics for different sectors out there, and we use whatever metric the market uses to value the security.

Q:  When you say history, how far back in time do you go?

A: Usually10 years.

Q:  So if you were to use as an example natural resource companies, how does your process work?

A: Sure, right now it’s very attractive to be looking at some of the oil or oil service names but maybe some of the coal or iron ore names are something I would not look at. So the third step of our process is fundamental work, which is where I spend 80 percent of my time, digging into fundamentals, trying to identify that fundamental catalyst or story or reason that we think the expectations of the stock have gotten too low.

Q:  Could you give an example that illustrates your investment process?

A: Alaska Airlines. The stock was trading in line slightly below its long term historical average so it popped up on some screens. Most airlines have very suspect balance sheets; they have gone through bankruptcy a few times, they have a lot of contingent liabilities in the form of pension and healthcare obligations, in addition to the debt they have taken on over the years. Alaska Airlines had a very clean balance sheet; it is a relatively new airline and had relatively new airplanes. This is a company that was able to buy new airplanes that were more fuel efficient, without having historical liabilities as an anchor around its neck. They’re doing a great job growing their business out of the Pacific Northwest across the country. If you were going to fly out of Orlando to Seattle, you’d probably fly Alaska Airlines nonstop. That’s a route they have, which is great versus having to connect. What I was attracted to was the fact that they were able to buy back stock, able to buy new airplanes without taking on huge amounts of debt. They were generating free cash flow, their network was growing, and they were also benefiting from massive consolidation, which all the airlines had benefited from: United/Continental, Delta/Northwest, Southwest/Air Tran. All these mergers that have happened brought pricing power back to the airlines. In addition, the airlines have all been showing discipline, so you are seeing steady price increases, discipline with cash flow, companies like Delta paying down debt, funding their pensions, not doing anything crazy such as growing capacity well above demand. So it has been a great environment and we bought Alaska Airlines. We sold Alaska Airlines after it had a big move because it reached its previously established price target and we had more attractive risk/reward elsewhere. One thing I think is very important is that buying stocks is easy, anyone can buy stocks, but knowing when the right time to sell a stock is just as if not more important than the buy decision.

Q:  The next question is – why did you sell it?

A: The valuation got to a point where it was back above its long term averages and at the same time Delta Airlines was making an investment in Seattle, their core and largest market. Delta was trying to grow capacity into Seattle, because they were going to use Seattle as the jumping off point for their Asian flights. So now you’ve got Alaska facing a big headwind and Delta going after one of their largest core markets, so we took our profits in Alaska Airlines and looked at better ideas elsewhere.

Q:  How does your research process work?

A : Our process is not a static process, it is dynamic. We are fundamental stock pickers and we go and do the fundamental work. Every company is different. There is no set criteria we use on every company, it is a dynamic process. With some companies we’ll spend more time on the balance sheet, other companies we don’t spend as much time on the balance sheet because they are relatively clean and we spend more time looking at growth opportunities or investment opportunities they might have. It varies on a company-by-company basis. It’s a bottom up, fundamental research driven process.

Q:  How do you find investment ideas and which idea do you dig further into?

A: The ideas come from our screening model where we use historical valuation data to identify low expectation companies and through our fundamental work we calculate upside/downside potential. If I have a company that has a 20 percent upside and 20 percent downside that is not really that attractive, but if I have a company that has got 5 percent downside and 40 percent upside then maybe we’d have a bigger position there, especially if it’s a more liquid one which means it trades more volume so we’ve got more liquidity. But if it’s 40 percent upside and 5 percent downside and yet it doesn’t trade very well it’s going to be a smaller position. So there’s a lot that goes into position sizes and also whether it gets in the portfolio or not. It is all about risk and reward, putting up what we think is a portfolio that will generate the greatest amount of return for the least amount of risk, which is what all portfolio managers are trying to accomplish.

Q:  Why is sell discipline important?

A: I do not believe in a “let your winners run” investment strategy. We are trying to put a portfolio together with the best return for the least amount of risk. When stocks reach our previously established price target, if the fundamentals are not better than what we thought, then we’ll sell that and find more attractive risk/reward elsewhere. I think too many people buy stocks but they do not know when to sell them and end up not doing well.

Q:  What kind of low expectations in the market are attractive to you?

A: We just look for companies whose valuations appear to be cheap relative to their history. At any one time there might be two hundred companies that fit that criteria. We have sector specific analysts so these analysts know their industries, know their sectors, know their companies very well and they’ll say that it doesn’t make sense that Company A is trading at such a huge discount relative to its history, when we’ve got X, Y and Z going on with this company. In the example I gave you of Alaska Airlines, it made no sense that it was trading at a discount to its long-term history and in line with the other airlines when it was a much better airline overall. With Alaska Airlines, the expectations were seated on capital return to shareholders; they sent more capital back to shareholders in the forms of higher dividends and bigger share repurchase. That exceeded investors’ expectations and the stock did very well. Maybe with the managed care organizations, the insurance companies that we own now, that’s pure earnings. These companies are exceeding expectations on the fact that they are making more money than anyone thought they would make and their valuations were just too cheap for what they were doing. There are a lot of different reasons for it.

Q:  How is your research organization structured?

A: We have seven analysts on our team, each with a sector specific responsibility. That is one of our competitive advantages, the fact that we have a small team but a very experienced team. Every stock that goes in and out of the portfolio is truly a collaboration with the analysts and myself.

Q:  How is the decision-making done and in the end who has the final veto?

A: As the portfolio manager, I make the final buy and sell decisions for the portfolio.

Q:  How are the analysts compensated?

A: The analysts are compensated on the overall performance of the portfolio. I want our analysts compensated based on how our clients are compensated. Clients enjoy overall portfolio performance and I want the analyst to be driven by the overall portfolio performance. If there is nothing in a sector that we want to own or should own then so be it. They are paid on performance relative to the benchmark and relative to a peer group over a rolling one and three year timeframe.

Q:  What do you do when you find that your thesis is not working or you are simply wrong?

A: We sell stocks. Sometimes we are just wrong on the fundamentals, sometimes the stock reaches its price target. You can’t be afraid to sell stocks, that’s why I think that this business is one part art and one part science. The science part is screening for dividends, doing the income statement work. The art side is knowing what the expectation levels are in the market and what we think the stock can achieve.

Q:  Do you keep a log of all the things you thought were right but were wrong and do you analyze it to see if there is any pattern to improve organizational thinking or learning?

A: No.

Q:  On the portfolio construction side, what is the role of diversification and what kind of diversification do you pursue?

A: We do not manage to the benchmark. I am cognizant of my position relative to the benchmark but I do not manage to it. We let the process guide us in our overweights and underweights. Sometimes we are zero weight in some sectors and double weight in some sectors.

Q:  What is your benchmark, if you have any?

A: The benchmark we use is the Russell Mid Cap Value Index.

Q:  At a philosophical level, what do you consider risk and what kind of risks are you looking at and how do you manage them?

A: We are long-only managers and we are paid to be fully invested so one thing I do not do is to make top down macro calls. As far as absolute risk controls go, you will never see us with a huge cash position in a portfolio because we think the market is going down. You’ll know as the client by looking at your portfolio what you’ve got with us. We have reports that we get that tell us macro things like if oil does this, your portfolio will do this; if interest rates do this, your portfolio will do this. Frankly, none of it surprises me when I read it because I’m fully aware of the positioning of the portfolio but I don’t manage to a benchmark. Risk is managed through position sizes and we own 60 to 80 names in the portfolio so that helps limit some of the single stock risk.

Q:  What is the maximum limit per holding and what is the initial position size when you start?

A: Initial position sizes are one to one-and-a-half percent and the max by proxy of the portfolio is five at cost but we never own more than about a three percent position, that’s about as big as we’ll go with 60 to 80 names.

Q:  Do you have any limits based on the sector or industry?

A: No, we don’t. Again, we do not limit ourselves. We will be zero weight at times and we’ll be double weight at times relative to the index. So I own zero telecom right now and, if you were to look at utilities and REITs together, I am 1,700 basis points underweight. REITs and utilities make up 27 percent of the benchmark and I am at eight. There is no arbitrary limit. We are benchmark agnostic. I do not manage to it but I am aware of my position relative to it. I understand that I have investors out there that that’s not what they’re looking for is a manager that would be 80 percent in industrials because I’m not an industrials ETF, so we manage it appropriately. If I’m double weight industrials and I’m underweight financials and I have an industrial stock and a financial stock I am going to put in the portfolio, all other things being equal, I’ll buy the financial stock if it’s got the same risk/reward as the industrial because I know that I’m massively underweight financials and way overweight industrials already. So we are cognizant of our implied bets but there is no hard and fast rule that prevents us from doing anything. That’s how we generate alpha.