Q:When do you reduce or sell your holdings?

A : Our sell discipline is based on our bias to be fully invested at all times. Since we do not sit on a lot of cash, every time we go through this process of monitoring a new name that we may want to add to the portfolio it is critical that we have a prioritization of names that are currently in the portfolio. Thus, if we find something better and cheaper, we look at the portfolio in order to find a stock that we like a little bit less than the new name that we have in mind. We have a constantly moving process of refreshment in the portfolio. Our sell discipline, in that manner, is very much intertwined with our buy discipline.

We generally scale into positions on a gradual basis in the range of 10 to 20 basis points at a time and, in reverse, we scale out of a position in a similar manner. We do not go in and buy 3% in a name and then some time later take all 3% out. According to our buy or sell discipline, we want to have a position in the portfolio reflective of our overall conviction in the stock based on the behavioral and fundamental valuation. We strive to keep the turnover ratio of the fund below 50%. It has been between 30% and 40% recently.

Q: What risk controls have you put in place?

A: When we think about risk there are three metrics for all the funds that we manage. The first being tracking error, which is a measure of the amount by which the performance of the portfolio differs from that of its benchmark. The second metric taken into account is absolute volatility, as measured by the standard deviation of the portfolio over time. This is also related to the concept of Beta. The third metric is basically downside risk.

Our easiest and most fundamental way of managing risk is diversification. We want to own between 90 and 110 names in the portfolio. If we see the ability to get paid for risk more handsomely, we may take slightly bigger bets and take more positions in the portfolio with a 2% to 4% weighting. When we see risk coming back towards the medium level, we will own a few more names so that we do not make a big bet one way or the other.

Portfolios made up of deep value stocks have slightly higher absolute volatility than the average value fund. Investors should expect our fund to have slightly higher standard deviation and slightly higher Beta than, for example, the Russell 1000 Value Index. The simple truth is that the characteristics of very cheap stocks are slightly more volatile. Our past performance record with the fund showed that the small additional risk taken was more than compensated for by the extra return we generated.