A: Last year we bought Aflac, a leading provider of supplemental health and life insurance products. The wellknown insurance brand is expected to generate over $15 billion in revenue this year, two-thirds of which will be in Japan. The duration in the Japanese market of the book of business is so long that new sales make up only a fraction of the cash flow of that large book of business. That is different from the business in the United States where you have persistency of about 75%, whereas in Japan the persistency is near the 95% level.

When you analyze the trends in Japan and the U.S., the new business in Japan is a smaller portion of the current book of the business than in the U.S. And, we were able to look past the fact that Japanese sales are off of Wall Street’s expectations. We reviewed our investment models including revenue and cash flow growth and we decided to buy the stock in the fall of 2006.

Another holding we have is City National Bank in Los Angeles, California. They have a stable franchise in wealth management and a great trust business. When the stock was sold off a couple of years ago, we took a closer look at the business, we talked to a few clients, competitors and area business leaders, and concluded that they had a strong and growing customer franchise in the region. This met our long-term business fundamentals criteria and we purchased the stock in May 2006.

Q:  How do you go about building positions?

A: We build positions slowly. Since we have a concentrated portfolio, we add positions patiently and build our target positions. Our portfolios usually reflect more seasoned stocks that have gone up in heavier weightings more than buying a large weighting in a new stock.

Q:  Generally, what is the turnover of the fund?

A: Turnover rates for all of the Ariel Mutual Funds tend to be low. The average turnover rate for Ariel Appreciation Fund over the past five years has been around 23%. Obviously, that number fluctuates based on valuations in the marketplace, the recent phenomena of private equity as well as the current number of company buyouts.

Q:  As a value investor what sectors do you avoid and what benchmark do you follow?

A: We are not concerned about benchmarks when we are building portfolios. Additionally, there are industries we have not invested in because they do not necessarily fit the QEV principle that we follow.

We avoid commodity-based sectors, whether they are materials, energy, and agricultural products. We also avoid certain sectors of technology which are of very competitive nature. We do not want to be involved in companies with product cycles shorter than eighteen months. These short cycles create significant revenue and earnings uncertainty. The volatility and unpredictability in the business model do not suit our long-term investment thinking. So we do not invest in some sectors as compared to a constructed benchmark.

Q:  What kinds of risks do you monitor and what do you generally do to mitigate them?

A: We diversify our portfolio across several sectors so we do have sector awareness but if there is a sector that is out of favor we certainly want to make sure that it is in our portfolio.

We do have risk awareness on stocks. We really worry about their impairment of capital; we have balance sheet measures as far as debt ratios and interest coverage ratios in order to make sure that we do not get into a situation where a temporary operating problem turns into an impairment of capital. And that is the risk that we worry about.

Our hurdle rate of 40%, stocks that are trading cheaper than our estimate of private market value serves as our best risk control measure. The classic Benjamin Graham margin of safety has served us well.