Q: What is your investment philosophy?

A: Our philosophy is based on four pillars. The first is that “information is not the bottleneck”. While years ago the key to successful investing was going out and uncovering information that wasn’t widely known, today you could argue there’s too much information with the implementation of regulation FD and all the online and electronic resources. “It’s like trying to drink water from a fire hose”.

The real key is being able to organize and successfully process that information. This requires a smaller, more reactive team that’s able to process both “active” and “passive” information. Passive information includes the financial statements and valuation measures, while active information includes things like price movements, management and strategy changes, corporate actions, regulatory changes – in other words, events that really change the model.

Secondly we believe you must “think before you screen”. Another way to say this is that you need to follow the fundamentals. Warren Buffett once said that the distinction between growth and value styles is “fuzzy logic” and we think he’s right. Defining yourself as a small-cap value or large-cap growth manager can be limiting. It works in certain markets and fails miserably in others. Instead, one ought to think about the market and what is important to it, not about what you believe the fund should look like irrespective of the environment around it.

Applying that thinking to the current market where small-cap stocks have outperformed large-cap stocks for over six years and where the normal discount is now a premium might lead us to spend more of our time looking at larger companies. So instead of telling the market what we’re going to look like at all times, it is better to listen to the market and let it determine what we ought to be favoring.

The third point is that “one size doesn’t fit all”. Just as Procter & Gamble won’t sell the same product in the same package using the same advertising the world over, neither should investors attempt to fit the world’s many stocks through one standard filter. In our work, Emerging markets require top-down decision making (being in the right country at the right time) while developed markets require more bottomsup work (finding the best stocks).

For example, when we compare beverage companies worldwide, Pepsi, SABMiller, Budweiser, Heineken, etc., we won’t put San Miguel brewery from the Philippines into the mix. Although it might be the cheapest or the fastest-growing beverage company at a given point, its performance doesn’t depend upon how beverages move. Rather, it depends on whether the market likes the Philippines. If the Philippines goes up, San Miguel’s going to be up and if Philippines goes down, San Miguel’s going to be down.

Lastly, we believe that “valuation is best thought of as a measure of risk”. We won’t buy a stock just because it is cheap or sell it just because it is expensive. Some expensive stocks do go up and some cheap ones continue to go down. What expensive really means is that if something goes wrong, there’s a long way for that stock to fall before it is going to find support. Cheap only means that if something goes wrong there is some intrinsic value on the downside offering protection. So, valuation is not a trigger for our buy or sell decisions, but rather a part of the overall process of defining the risk inherent in a name. Ideally, we like to frame our work using Michael Porter’s “Five Forces” model for industry analysis and we’re willing to pay more for companies that screen highly on this work.

Q: What is the process that drives your top-down or bottoms-up decisions?

A: In the emerging markets we’re looking at macro economic indicators, such as current account balances, fiscal deficits or surpluses, capital flows, etc. In the developed markets we scrutinize each sector to find the best of breed companies. We spend a lot of time analyzing the key drivers for any given industry and we judge the investment value of an individual stock on the basis of those factors.

While in the emerging markets we analyze whether this is the right time to be in the particular market, in the developed markets we are trying to find the best pharmaceutical company or the best energy company. Before we start doing our research, we have to know what we’re looking for. We thus identify the factors that make a pharmaceutical company successful. These factors change over time, but today include things like a favorable patent expiration schedule, strength of product pipeline, R&D spending and what we are paying for currently identifiable products versus what we are paying for the promise of the pipeline. Another factor is whether these drugs are unique or not. For example Lipitor, Pfizer’s cholesterol drug, is the biggest selling drug in the world. However, there are half a dozen other equally effective cholesterol drugs out there and though Lipitor’s U.S. patent is protected until 2011, it is going to suffer because it’s not a unique drug – Merck’s Zocor just went off patent and we believe generic cholesterol drugs will hurt Lipitor almost as much as they will Zocor.

Energy requires an entirely different set of metrics. There, we are looking to acquire reserves at the lowest cost (Enterprise Value per Barrel of Oil equivalent). Whereas Exxon trades around $12 or $13 per boe some of the Russian names trade at $2 or $3 which has led us to favor Russian names when we want energy exposure.

I should also mention that Japan, to us, is a hybrid market, necessitating both a top-down and a bottom-up approach. While the Japanese economy has global champions like Toyota or Sony and we compare those to their peer group, they also have some closed sectors, like construction or finance, which are more dependent on the performance and the economic characteristics of Japan. These closed sectors will be examined relying primarily using a top-down process.

Q: How is your research process organized?

A: The greatest amount of value we can add is at the beginning and the end of the process. You’ve got to think about what drives stocks/industries and what you want the portfolio to look like (idea generation). Then, at the execution stage, a little skill as a trader comes into play. But the data gathering, what is done in the middle, is something that we like to pass along to the analysts.

We may use our Zurich analysts or Wall Street’s – whoever is best equipped to answer the question. For example, in the drug company situation we discussed earlier, we’re not going to spend time looking at every drug company to see which products expire this, next and the following year. That’s important but we’re not going to be able differentiate ourselves gathering the data. We’ll let the analysts do it and send the results. We’ll spend our time analyzing it and making decisions based on the factors that we originally thought were important. This is where we can add value.

The other important issue is making the distinction between active and passive information and knowing where to spend your time. On September 11th, the U.S. markets closed as the World Trade Center and Pentagon were attacked. European markets, however, were open and the insurance sector sold off dramatically. We were able to do a quick analysis of the worst-case scenario, the costs to insurers to replace the World Trade Center. We compared that to the amount of capitalization lost and saw a buying opportunity.

Q: How would you explain the fact that you could come up with the total damage for the World Trade Center in two hours while the insurance companies could not come up with an estimate?

A: What we had to do and what the insurers had to do where two different things and people often confuse them. Insurers are running a business and they had to ascertain, with reasonable certainty, what they would have to pay. All we had to know was whether the evaporation of sector market capitalization was more or less than the worst-case cost to rebuild these things. In the end, the number was much less than the loss in market cap of these stocks. With the gap that wide, it became an easy decision to buy the insurers even though we didn’t know the precise costs.

The same is true on a day-to-day basis. We don’t think that we have to know whether IBM is going to earn exactly $1.35 next quarter. The important factor is whether their earnings are well above the trend or below it. It’s all about being directionally correct and avoid being precisely wrong.