A similar name is Coventry Health Care, which is also in a very stable industry. We believe that Coventry, which currently has a BB credit, can actually become investment grade. Given our current outlook and the search for higher quality, both of those names satisfy our research criteria. In an uncertain economy, they represent good stable businesses with the potential to be upgraded.

On the equity side, our top three holdings are Progress Energy, Altria, and Kinder-Morgan. Although they are in three different industries - utilities, consumer products, and energy - all of them have good payout capabilities. These companies first passed our quantitative dividend screening process. From a fundamental standpoint, Altria generates prodigious cash and has a dividend yield of over 4%. It is a very stable business with a long history of increasing dividends. It recently spun off Kraft Foods and is in a bullet-proof industry environment right now. Since the company fits all of our criteria, it makes up about 4% of our equity allocation.

On the REIT side, our top three holdings are Hospitality Properties Trust, Simon Property Group, and Vornado Realty Trust. Again, they represent three different areas in the REIT space, so that allocation provides diversification. Hospitality Properties is in the hotel business, Simon Property works predominantly on the retail market, while Vornado is focused on the office space. They are large companies that offer reasonable dividend yields and dividend growth.

Q:  What are the most important elements of the portfolio construction process?

A: As a result of the screening process, it tends to be a relatively concentrated portfolio. Right now we have about 85 high dividend-paying stocks. The REIT portfolio only has about 60 to 65 names because the REIT market tends to be more homogenous.

Our long-term model allocation is 45% in fixed income and 55% in equity. On the bond side, that 45% exposure consists of 40% in high-yield and 5% in investment grade bonds. On the equity side, our model allocation is 23% in REITs and 32% in high dividend paying stocks.

We first follow the three main categories – bonds, dividend-paying stocks, and REITs - and then look at the sub-sectors to evaluate which one offers the most attractive expected returns, both from the perspective of dividends and capital appreciation. The question of the least downside risk is also important, especially in the current environment, when everything looks a little elevated.

Then we go through an allocation to each of the main areas for positioning that gives us the best risk/reward profile depending on the current market outlook. So the portfolio construction process represents constant calculation of the yield of the asset class and comparison on a statistical basis.

Finally, it involves judgment in terms of our overweights and underweights. The degree of the overweights is dictated by how rich a certain sector is compared to another sector or to its historical performance.

Q:  What kind of risks do you look at and how do you monitor and control them?

A: We’re fully aware that when you screen for high dividend-paying stocks, you will naturally lean towards certain sectors, such as financials and utilities. For risk control purposes, we optimize the portfolio to make sure that the leaning doesn’t get too extreme. For example, when some of our financial stocks run up quite a bit and we were getting too heavy in financials, we pared those back and consciously sought for diversification in other industries.

Long-term risk management is most important since one of our portfolio goals is long-term capital appreciation. Our quant group runs an analysis, which shows the probability for the portfolio to achieve capital appreciation over a 20-year period. We try to keep that number at about 70% to 75%, and if we deviate too much from our static model, that probability drops.