Q:  What is the investment philosophy of the fund?

A: There are three things we consider very important. First, valuation is critical to our investment decision. We look for ideas with a margin of safety. Second, we think about investment opportunities over the long-term. We are very patient and try to find companies that can improve over a three- to five-year horizon. We are trying to own a business rather than a stock, so this leads to fairly low turnover.

Third, we develop a concentrated portfolio and are willing to take sizeable positions if the opportunities warrant. We are trying to make fewer but better decisions. For large-cap value, generally we own between 30 to 50 names.

Q:  What is large cap from your perspective?

A: We define large cap companies as having market capitalizations greater than $10 billion. The majority of our assets are in large capitalization stocks but the weighted average market cap for the portfolio has typically been below that of our benchmark, the Russell 1000 Value Index.

Q:  What is the value that you’re seeking?

A: We look at value using enterprise value divided by invested capital (EV/ IC) as the relevant metric. As of March 2006, the S&P 500 had a median EV/IC ratio of 2.1 times. We look for companies trading below that market median.

Q:  How would you describe your investment strategy?

A: Fundamental analysis and valuation analysis drive our efforts. We consider ourselves bottom-up, fundamental analysis driven investors. Through our fundamental analysis we’re trying to understand whether it’s a good business or not. If it’s not a good business today, we’re trying to determine if there is potential for improvement. We believe that good businesses are able to sustain or improve their pre-tax return on invested capital (ROIC) ratio over time. Our valuation analysis helps us understand whether this fundamental assessment is priced into the security today. We buy those companies where the market price does not reflect our expected value. We do this one company at a time.

In assessing the business, we try to understand if a company has a sustainable competitive advantage. I think about it as a triangle with sustainable competitive advantage in the middle. The three sides of the triangle are management, resources and opportunities. For management, we’re trying to figure out if we understand the strategy of the management team. Do they have a history of creating shareholder value? Culturally, are they people you would want to work for? I firmly believe that the culture starts at the top and works its way down.

For resources, we consider whether they have the financial resources in place to sustain the business and the human resources to execute the strategy. Regarding the industry opportunities, we consider how competitive the industry is, how the industry is growing, and does the company have any unique product or services to offer.

In our valuation analysis, we use the fairly typical valuation metrics, but we’ve also created our own tool set. If you imagine a graph, on the Y-axis you put EV/IC and on the X axis you put pre-tax ROIC. The X-axis shows how good the company is because the better the company or their competitive advantage, the higher returns they generate. We are able to plot all the companies in the universe or industry. Historically the market has shown a relationship between these two variables. We are able to fit a curve through the plots. We draw a line straight across the current market median of 2.1 times and the universe below that line is the one we’re looking for – undervalued companies.

This tool allows us to compare how the market values a company today and how they have valued it in the past by comparing it to the overall market and industry peers. New ideas typically trade at EV/IC levels where the market is not reflecting its current or future pretax ROIC.

Q:  Do you tend to prefer companies that are below the market valuations?

A: Yes. However, not every cheap stock is an attractive idea. The error in value investing is that some companies will never earn higher ROIC figures. Some of the firms here will never be able earn above their cost of capital. So we are looking for companies that are trading at attractive levels but have the opportunity to be a better company over the next 3-5 years.

Q:  Modifying the book value of the mining, oil, or energy resource companies is a little tricky. How do you deal with that?

A: We can fit some of those companies into our valuation framework, but for some industries it does not work. For those where it does not, we use more traditional metrics. We try to focus on companies in our circle of competence and we try to expand it over time. When we make a mistake, we always try to evaluate what we could have done better. For example, it’s amazing what some of the raw materials or the commodity companies have been able to do, and we’ve underperformed in that group because we don’t know that group as well. But we’ve made it up in other places.

Q:  Do you put similar emphasis on valuation metrics such as free cash flow or is that less important than the EVIC?

A: Free cash flow is one company lever that can influence a company’s ROIC. I can tell you what the free cash flow yield is on every name that we own or look at. At this point, we have not built the tool set around it, but we certainly think about it.

Q:  How would you describe your research process?