A: First, we stay fully invested. We’re not trying to time the market by holding cash because we believe that it is the financial planner who should devise the portfolio allocation for the individual investor. We want to make sure that we’re not messing up the portfolio allocation for that investor by cash of funds that he has allocated for mid-cap core assets.

We have a custom-built mid-cap benchmark that’s based on Lipper's peer group. We also look at the S&P 400 Mid- Cap index, so we use those two benchmarks for diversification guidelines and for a gauge to being overweight or underweight.

In terms of the number of securities in the portfolio, we’re in the 125 to 200 range, with the sweet spot being around 150 stocks. We believe that this number gives us the appropriate balance between diversification and the ability to use our stock selection process to add value.

Probably the most unique aspect of the portfolio is that we break it down by growth and value. For example, Brian is responsible for healthcare, technology, telecom, and financials, while I’m responsible for the consumer area, energy, industrials, materials, and utilities. As we both come from the analyst side, we’ve covered all these sectors. Often our competitors would cover one or two sectors and do a good job, but they don't have the pure analytical experience in each specific sector which Brian and I bring to the table. We know the inner workings and the critical aspects that we should be focusing on.

Q:  Could you give us some specific examples of investments that have worked out and some that haven't?

A: Since we started managing the fund about two years ago, our largest overweight has been the energy sector. That’s where we saw a lot of positive fundamentals both at the sector and the company level. We saw strong energy demand and supply wrestling to keep up with demand; we saw excess capacity being eroded and inventories falling over the last couple of years. Yet, the companies were very cheaply valued and there was a lot of insider buying in early 2004. From the bottom-up perspective, the free cash flow and the return on capital were increasing. We also saw positive earnings revisions and that led us to a substantial overweight in energy for the last two years.

Recently, that trend reversed as the stocks had tremendous run over the last couple of years. Now the demand is starting to taper off, supply is starting to grow at the margin, inventories are increasing instead of decreasing, and excess capacity is also starting to increase. The valuations have become quite full, so we’ve been reducing our overweight to the point of being underweight in energy. That’s an example of a combination of our bottom-up process with a top-down overlay.

Q:  Which industries are you currently overweighting?

A: One area that we’ve increased our exposure to is technology as we're seeing spending trends that are fitting many of our criteria. Specifically, the area that we focus on is semi-conductors. Typically, when unit growth gets to the level that we are, that would be a signal for us to sell. However, during this cycle we're seeing much more capital spending discipline by the semi-conductor companies and on top of that, the inventory levels are still low. Valuations are at more reasonable levels than the last time that we’ve been at that part of the cycle.

So we dug a little deeper and it appears that the companies have more focus on return on invested capital and much more capital discipline. And while we may see a short downturn during the first quarter with consumer spending pulling back, we think that the downturn will be much shallower than expected.

Q:  What are the key aspects of risk control? What is your buy and sell discipline?

A: Each portfolio has risk constraints that we must stay within. The quant team constantly runs our portfolio against those constraints to make sure that we’re within the guidelines. So when we construct the portfolio we can’t put it all into technology or all into energy. Typically, we aren’t more than 1.5 or 2 times the benchmark weight. We aren’t less than 0.5 the benchmark weight, so if we are completely wrong in our analysis, we won’t get blindsided and end up in the 90th percentile.

We also keep maximum individual position limits of 2% in any particular name, but we'd get to the 2% position only when we have all the stars aligned between our fundamental research, insider analysis, and valuations.

We have in-house investment tools, including quantitative research tools and riskcontrol measures that help us evaluate how much risk an individual security is contributing to our portfolio. From a bottomup, stock-specific perspective, we need to see that we are valuing the security appropriately, while from a top-down perspective, we check the diversification and the risk-reward profile of the overall portfolio.

We value each company before we buy it, so we have an estimate for its intrinsic value. We also incorporate a downside protection to better evaluate the risk-reward for each individual stock. We monitor price movements that may trigger revisiting the company to check if everything is on target, if the valuation has become full, if new information could mean further upside and increasing our price target. If the stock has fallen, we check if there is anything we’re missing.

We'd sell a growth name when we see deteriorating fundamentals relative to expectations and we'd sell value names if the valuation exceeds our target and we can’t justify the ratio. We reverse our buy screens to see if there is anything in the portfolio that should be sold. For example, if for a growth name the estimate revisions are decreasing, insiders are selling into price weakness, that will definitely show up on our screens and we would typically sell that stock.