A: Aflac Inc. represents our stock research and investment preference. It fits into our secular growth requirements as it provides supplemental insurance in the US and Japan. And, over the years Aflac has managed to grow earnings between 13% and 15% a year. Aflac with its product offerings is still underpenetrated in the market and it meets our criteria of secular dynamics.

First, over 75% of Aflac’s earnings come from Japan. We have a fundamental belief that the dollar is going to be weak over the long haul, so having 75% of your earnings coming from Japanese Yen is a very valuable franchise.

Second, in the United States Aflac is underpenetrated with its supplemental insurance and has tremendous growth dynamics, so the other 25% of earnings in the U.S can continue to grow. Third, Aflac has no subprime mortgage exposure so it’s not involved in the current credit crisis.

Fourth, Daniel Amos has been running the company for decades as an owner operator and the management team is hungry to build longer term wealth.

Fifth, Aflac increased its dividend every year and is actively buying back its own stock. The board of directors is shareholder-friendly as it’s got the corporate ethics we’re looking for. They are in secular growth where they stick to what they know. They don’t go out and do acquisitions in markets they are not competent in. They have got a great international business that’s non-correlated to the US economy. That’s the kind of businesses we want to own.

Q:  How do you define intrinsic value?

A: First, we look at discounted free cash flows over 10 years and put a terminal multiple on discounted back and it gives us an evaluation of what the company’s worth.

We’ll do different scenarios on growth and margins to get a view of the over/ under bet. We like to call it a ‘growth solver’,saying that if, for example, Google can grow 19% with a 30% operating margin next 5 years, what’s that worth? This gives us an over/under look at what the market expectations are and then we make investment decisions based on that.

Second, we have a valuation criterion called ‘Holt Value’ and it values companies based on the excess economic return they make. In a nutshell, how much capital can you put to work, what’s your discount rate and what’s your return on that capital.

Q:  How do you build your portfolio? How many stocks do you have and what is stock turnover in the fund?

A: Generally we hold 60 to 65 stocks, which makes our portfolio relatively concentrated. We don’t typically overweight a sector more than two times the S&P 500 index and we don’t underweight a sector more than 50% of index weight. In terms of diversification, typically the top 10 holdings of the portfolio represent around 30% of the fund.

In the last couple of years our turnover has been higher than I would like - around 100%. A couple of years ago we significantly underweighted financials and that caused some turnover. Some stocks have been near the high end of their trading range and we have a tendency to pare back and then add when they get to the lower end of their trading range.

We allocate capital in two ways. The first is what we call permanent capital and the second is opportunistic capital. That adds to turnover as well because we actively manage our holding in companies to take advantage of market volatility. In a perfect world, turnover may be 50% to 60% but in recent years it’s been up at 100%.

I’ve hired several strong analysts in the last three years and as we have populated the fund with their ideas that has increased turnover a little in the short term. I’ve also harvested some gains from the time when I had more names in the portfolio.

Q:  What kinds of risk do you monitor and what do you do to mitigate it?

A: We use macroeconomic analysis and top-down analysis which helps us steer where we think the economy is going. We also try to capture most of the risk at the company level by drilling down and doing rigorous research.

If you do extensive company-specific research it forces you to delve into the macro economics analysis and try to do sensitivity analysis for the company’s stock during the different phases of economic cycle. We always keep in mind whether the company’s products will be more relevant in the next three to five years, and if so how the stock will trade when the investment environment is favorable or adverse.

We are always trying to understand where the secular and demographic shifts are, where a specific stock or sector trades in recessions or economic expansions, and what are the historic multiples. We also try to understand risk based upon a lot of probability diagrams of where the market values different companies in a recessionary environment, and how the current cycle is different from the previous cycles.

We have 10 or 15 different metrics to evaluate risk including industry dynamics, the secular dynamics, demographics, and global growth. While we think at the macro level we also analyze where the company fits in the economy and in the industry.

Our portfolio tracking error has typically ranged between 4% and 5% and reached as high as 7%. Our goal is to be at a certain point uncorrelated to the benchmark. We are an actively managed fund so our tracking error tends to be on a higher side of the range.