A: Although there are differences when researching stocks and bonds, there are many similarities in our approaches. We want to understand the companies, their business, and how they make money.

As far as bonds are concerned, we spend a lot of time in understanding the business, the expected profitability, and the cash flow generation ability of the company. Most of the bonds we like typically have short maturities and, consequently, our analysis does not have to be a long-term analysis. We look for what the company is doing currently, the projections, and what we expect in the foreseeable future. Then we spend a lot of time looking at the balance sheet, the current capital structure, the amount of cash on hand versus near-term debt maturities. We examine the company’s ability to access the capital markets if we think that they’ll need such access to retire debt. We don’t like to gamble on the fixed income portfolio.

Regarding the research of equities, again we try to understand the company, the industry, how the company makes money, what trends the income and cash flow statements show. We focus on the company’s ability to generate free cash flow and to use that cash flow wisely. We also check to see if the management’s interests are aligned with the shareholders, if its strategies will help to increase the stock price, and we’re looking at management motivation.

In general, there is no formula. We don’t have a computer program that spits out 12 different names a week. Basically, we do it the old-fashioned way, reading the 10 ks, the 10 qs, Annual reports. When wall street research is available, we’ll look at it, although we’d rather understand the company ourselves. We also read industry materials, articles in the press, and we’ll talk to the management if we think that’s necessary. We visit companies if that’s helpful, although sometimes that can hurt you if you get too wound up in the romance.

Overall, we follow a process of understanding how the company makes money, familiarizing ourselves with several years of financials, understanding what they’ve done in the past, how the management has run the company and reinvested earnings over time. So it’s a process that is not by a formula, but one that requires a lot of involvement from us.

Q:  Moving on to portfolio construction, how many stocks and bonds do you have? What is the split between stocks and bonds and is that an important issue for you?

A: Currently we have about 45 stocks and 20 bonds, which is a fairly typical distribution. We believe in making investments that are significant enough to affect the portfolio’s performance. Our risk management is accomplished by good market research and analysis; we’re not proponents of overly diversifying the portfolio.

We don’t believe that there is any bene- fit in owning 200 equities as opposed to owning 30 equities. With our approach and the research-driven methodology that we use, we would rather own 40 or 50 equities in the portfolio that we understand well. We wouldn’t buy the top 12 names in the telecom sector, for example, just because we’ve decided that we like that sector. We have a bottomup approach and we keep the names down to a reasonable limit so that we can understand them well, while at the same time, we’re not over-concentrated in any particular company or industry.

Q:  What kind of risks do you perceive and how do you monitor and mitigate them?

A: We have tremendous focus on capital preservation and that has been a real driver for our fund. We have been able to perform well during difficult stock market environments through credit analysis, spending a lot of time on balance sheet analysis, cash flow generation, and the company’s ability to access the capital market. Also, we keep the duration of the bond portfolio very short so the holdings are not swung around by changes in interest rates. That’s how we limit the risk of the bond portfolio, which has been a stabilizing factor of the overall portfolio.

In terms of equities, we’re very patient when we buy stocks. We don’t invest until we have a good entry point and we’ll wait for the risk/reward that makes sense to buy for our fund.

On the sell side, we’re more than willing to sell securities when they trade at what we consider fair value. When the situation does not develop in the way we anticipated, we don’t hesitate to sell. If the initial reason for the purchase is no longer valid, we spend time re-evaluating things and it’s been very valuable to cut losses quickly. That’s the mentality and the framework that helps us do pretty well during a difficult stock market environment.