Q: Could you give us some examples that illustrate that sale process?

A: Sure, first let me say a copy of our buys and sells for the past year is available on request. Last year we owned Kerr-McGee because we thought that it had an excellent valuation and good growth opportunities in exploration and production. It turned out that Carl Icahn agreed when he acquired a position and convinced the company to take actions to realize that value. That drove the stock to the point where it became too expensive on our discipline forcing us to sell it and redeploy those assets elsewhere where there was better value. We ended up putting the money into Marathon Oil and it worked out very well.

Such a discipline forces you to sell stocks that become expensive, even if they are still in favor in the marketplace. It forces you to look at the long-term values, not at the current sentiment.

Fannie Mae is another example where the structural catalyst we had liked was removed because of concerns about accounting. We had that name until the middle of 2003 and it had been a longterm holding for us. The price/intrinsic value was still attractive, but we couldn’t be sure if the underlying assumptions still held true. That’s a negative catalyst that forced us to sell the stock because we couldn’t trust what we were seeing.

Q: That’s very helpful for understanding your sell discipline. Would you also give us an example why you would buy specific stocks?

A: We bought Texas Instruments at $23 because it was attractively valued on a price/intrinsic value basis with new products geared towards the digital consumer market. They had the Digital Light Processing chip (for large screen TVs) and were gaining share in the cell phone component market. With an attractive value and catalysts for growth, the company had been exceeding analysts’ estimates as well. We added it to the portfolio because of that robust outlook.

We’re playing the consumer electronics theme in a couple of names in our portfolio including Best Buy and Texas Instruments, so we’ve got the production and the distribution sides. We chose this theme because Americans like gadgets. The last time I checked, I didn’t see a group of 30 people huddling around a 19” tube TV. People like to hang something the size of a doormat on the wall and watch it. Maybe that sounds simple, but people just like bigger TVs, better resolution, and more useful cell phones.

Overall, we’re looking for a catalyst that will position the company to outperform expectations and peers over the next four to five years. The catalyst can be new products, restructuring, potential expansion, or potential new government regulation. The average turnover of the portfolio is between 20 and 25%, often less than that, so we’re true to the discipline of a long-term holding period of these names.

Q: What are the milestones of your portfolio construction process?

A: We use the S&P 500 as our benchmark for sector weighting. We’re allowed to have moderate sector variations but we cannot be entirely out of a major S&P sector or widely overweight in that sector. For smaller sectors, like materials that represent 3% of the S&P 500, we might have to 9% in the portfolio, but that would be very unlikely.

For the larger sectors, like financials that represent 20% of the S&P 500, we can vary plus or minus half the underlying weight of the index, so we can be anywhere in the range of 10% to 30% of the index. Typically, we don’t vary that much, but these are our official guidelines. This policy ensures that when one sector is aggressively moving up, we have to participate, but as stocks get expensive, we have to move into more attractively valued stocks within that sector and we’ll probably go to the lower end of our weighting range.

Q: What is your view on risk control?

A: The risk control consists mainly of the diversification and the sell disciplines. We augment this through continuously reviewing names, especially names that have weakened significantly versus their competitors over the past couple of months. We have weekly research meetings to discuss names and ask ourselves if these stocks are going through normal pullbacks or if there is something structurally different. So the risk control involves constant monitoring, the sell discipline, and diversification. But it also includes the intangible experience of four people from four different generations and with different perspectives, discussing each of the securities in the portfolio.

Q: How important is customization for your individual clients and how do you handle it? Do you receive many requests to restrict specific sectors that individuals may already be exposed to?

A: Up to a point you can do customization, but you have to make sure that you still have the integrity of the portfolio to meet the expectations for the clients overall plan. If that’s not possible, you won’t meet the client’s expectations, and everybody will be unhappy. So, we do customizations within reasonable limits. We hate turning away clients, but we hate even more damaging a relationship or not meeting the expectations for clients. You have to do the right thing for the client for the long term, or you won’t be in the market for long.

A copy of the buys and sells of Todd Investment Advisors for the past year is available on request.