Q: Would you describe your investment philosophy?

A: Our philosophy is based on a long-term view and emphasizes diversification, high-quality bias, valuation discipline and below average risk. We think that a diversified portfolio of superior companies bought at attractive valuation levels, produces attractive risk adjusted long-term returns.

Our fund is a large-cap blend or core fund and we think it is a very compelling place to be. On the value side, there is large sector concentration in financial stocks, while growth funds depend more on the fortunes of the technology sector. We like the latitude that we have in the large core or blend area because we are able to move slightly in one direction or the other. For us, reasonably priced high-quality growth represents a very compelling risk-reward situation.

We are looking for the following qualities in the companies we buy: strong business franchise, credible and capable management, sustainable growth prospects, disciplined capital investment and strong free cash flow generation. We like companies that have discretion in terms of share re-purchase, dividend growth, or strategic acquisition.

Valuation is a crucial part of our investment process. There are many great companies, but if they are not purchased attractively, the risk-adjusted returns may be disappointing. The philosophy of strict valuation discipline and quality bias tends to help the portfolio perform better in down markets.

Q:  Do you place your emphasis on consistent earnings, above-average earnings growth, or tax-efficiency, for example?

A:We have a long-term time frame and are looking at names that we can own for several years. Turnover is in the range of 35% to 50%. Our strategy is buying companies that have positive multi-year outlook, rather than buying on their first strong quarter or in front of a specific news event. We accumulate positions when things tend to be quiet and hopefully in front of a catalyst.

We look at valuation on any number of metrics – company relative to its history, its peers, and the market over time. We evaluate the upside potential, but with an emphasis on the downside risk and also using the dividend dis count model. We have to be confident that the valuation is sufficiently attractive and in the worst case, the downside is limited.

Q:  How do you implement this philosophy into an investment process?

A: Our investment process starts with a very broad screening methodology of companies with market capitalization of over $2 billion and adequate liquidity. Some of the important metrics are higher than average ROE and free cash flow yield that is above market levels.

Thematic overlays are also an important part of our process. The large cap universe is quite efficient and you need some latitude in terms of sector weights to differentiate yourself. We are not sector rotators, but there are clearly some strategic themes that we play to our benefit.

For example, the positive stance on energy over the past 5 years and the ramifications of the rapid growth in China led us to basic materials stocks in 2003. We currently are invested in commercial aerospace and international infrastructure. The fundamental analysis gives us a number of potential candidates. We then develop some themes and biases that might lead us to overweight certain sectors and underweight others.

Q:  What are some of the peculiarities of investing in large cap stocks?

A: The multinational aspect is very important, because the companies we invest in are global in nature. From time to time we may own several ADRs, when they have better value or a compelling story, but they have to be liquid.

Although we have been consistent in running predominantly a large-cap portfolio, we have some flexibility regarding the market cap size. Currently, the fund has a weighted medium market cap of above $40 billion. Large-cap stocks are about 85% of the fund, while stocks with market cap of $2 to $10 billion represent 15%.

Usually, we go down the market-cap spectrum when we see distinctly better values or unique situations that are not available in the larger-cap universe, like in the period 2000 to 2004. At various points of time, our average market cap has gone down to $20 billion.

However, this phenomenon has largely been discounted and predominantly large-caps portfolios have an excellent risk-reward profile. In many cases, the large cap names in the same industry trade at discount to some of the mid-cap names, despite having more diversified and better business models.

Q:  What is your formal process of research? How do you start, top-down or bottom-up?

A: It is mostly a bottom-up approach. First, we look at some basic screens to work down the investable universe. We consider the discipline, how the management spends money over time, whether they generate free cash flow, what the returns on these businesses are. We look for better business models with brand names, installed user bases, recurring revenues. We focus on companies that have strong shareholder returns and are consistently profitable over time.

However, when circumstances dictate, there is plenty of room for economically sensitive or cyclical companies in the portfolio, like basic materials and energy. If the returns are not consistently high, we look at situations where we expect a substantial improvement.