Our quantitative screens help us to look for companies with rising cash flows after adjusting for accounting standards. We’ll screen for free cash flow generation and recapitalization potential. We are trying to look for companies that might be attractive to private equity buyers.

We also use qualitative screens to look for transformational events: management changes, announcements of a restructuring or a spin-off. We look for changes that would offer the potential for the company moving from a less attractive opportunity to something that we like. Once we have identified the investment opportunities, we conduct fundamental bottomup analysis on the stock. We focus on management quality, we look for their history of success, we look for the examples of their strategic vision, and of course, for their shareholder orientation.

We also go through a thorough process of evaluating the business. We look for industry drivers and the competitive position of the different players in the particular sector. We look for supply and demand characteristics and for sustainability of cash flow and earnings. We also spend time looking at the financial strength of a company.

For each one of the investment candidates we’ll develop an investment thesis. We’ll try to identify the specific value of that business, and hopefully if the market is undervaluing that particular opportunity, then we’ll decide to buy or sell with a determination of a price target and the downside risk.

Q: Could you give an example to illustrate the process?

A: There is a Switzerland-based company in the hearing aides business that we have owned for a while. It is called Phonak. We identified the stock through a top-down thematic approach as we looked at demographic trends around the world. The baby boomer generation is aging but they have a strong desire to have a higher quality of life later in their years. That led us to look at a number of medical tech companies and we started to look at hearing aides as an investment opportunity.

People did not use hearing aides in the past because they were bulky, cosmetically unattractive, and they did not work very well. Those impediments are going away because this is a sector that is benefiting from miniaturization and from technological sophistication.

We started with a relatively small position and as we saw that the management was delivering exactly on what they were promising, we increased the position. This is not a cheap stock based on some traditional measures of say P/E or price to growth. This is a high-quality company that is generating phenomenal returns and we’d love to own it for a very long time.

Q: How do you control risk?

A: We like the idea of a relatively diversified portfolio. From a risk perspective, any position above 1% is considered to be a relatively highly concentrated bet. We also like the idea of being able to express our themes through a number of names. Sometimes when we find more than one company in a sector that meets our investment criteria we spread our investment over multiple names rather than selecting one name from the sector.

There are very few names that are above 1.5% in our portfolio, so anything that is above 1% has to be a high conviction bet for us.

Q: How would you describe your sell discipline?

A: The sell decision has to reflect the change to our investment thesis. It could be that the management has veered off from what they announced they were going to do before, and we do not like that. Sometimes companies could disappoint in terms of their numbers or their ability to be successful in a certain market. Sometimes the sell discipline is going to be triggered by valuation.