The analysts present those names to the portfolio management group, where we discuss the critical variables, why the stock is mis-priced, where the potential upside surprise or downside risks could come from, and how that could affect the valuation. What we’re looking for is a differentiated point of view from the consensus, the rationale behind that point of view, and the level of conviction.

For example, the reasons behind a betterthan- expected performance of an auto company may include a platform-sharing agreement with another player, which enables it to lower the cost and to price the product competitively, or its sales and distribution network, its service network, etc. Another reason may be examining all the potential future outcomes and deciding that the market doesn’t necessarily prices correctly the alternative outcomes.

If everyone agrees that a company’s new product will help them grow sales 6%, then the market factors 6% in future projections. But the product may be an unexpected hit, such as Nintendo, for instance. Two years ago the consensus opinion was that X-Box was going to be the leader, PlayStation 3 would be a close competitor, and Nintendo was dead in the water. Today X-Box and PlayStation 3 are having price cuts, while Nintendo is very successful. So two years ago, the Nintendo stock was not priced for success and it had very limited downside. The risk/ reward in that case was very favorable, even if you couldn’t be sure that the product was going to be a huge success.

Q:  Could you give us examples of specific stock picks?

A: One example would be EFG Eurobank, the second biggest bank in Greece. It has about 500 branches in Greece, where the penetration of financial products is accelerating as per capita GDP goes up. Currently, the company has market capitalization of 12.5 billion euro and is trading at 12 times earnings. The stock scores very well on historic metrics because it’s growing well in its home market.

More importantly, our fundamental analysis and insight led us to be even more positive because of the over 1,000 branches that the company has opened in Eastern Europe, including Romania and Bulgaria. So EFG Eurobank will be able to benefit from the improved GDP and personal wealth growth in those markets as well. Many other banks are starting to see Eastern Europe as a tremendous opportunity and the recent transactions show that banks have been paying an average of about $9 million euro per branch.

The simple calculation of 9 million euro per branch for 1,000 branches leads to market value of 9 billion euro, which compares to 12.5 billion euro market cap. That value of 9 billion euro isn’t currently generating any net profit, but will be shortly because of all the investments in the infrastructure and the growth rate. Combined with the core earnings generated today, that reflects a earnings multiple of 5 to 6 for a company that is growing at 10% rate. That essentially is a discount that gives us a margin of safety.

Q:  Could you highlight your portfolio construction process?

A: Through our process, we generate a score for every stock, and we can combine them based on the alpha opportunity versus the risk of owning that name. Our objective is to find those 80 to 90 names for which we have a high degree of confidence, and then we look at the right position size for every name.

About 70% to 80% of our portfolio is active share relative to the benchmark, which means that only 20% to 30% of our portfolio actually would be represented in the benchmark. There are over 1,000 names in the EAFE index right now, and our portfolio is actively managed relative to the benchmark. So we’re more focused on finding names for which we have a high level of conviction. These names may or may not be in the benchmark, but if they are, we make sure that we have an active position in them relative to the benchmark.

Since we are bottom-up stock pickers, we don’t want large sector bets to overwhelm the stock specific risk. We don’t have specific targets for the weights of stocks, sectors, countries, or region, but we don’t want any name to be too large and we want every name to be able to contribute to performance. The goal is more than 70% of our risk to be stock-specific risk, and to have names with high probability to outperform. That increases the probability for the portfolio to outperform.

Q:  What is your view on risk control?

A: We have a biweekly portfolio construction meeting and a dedicated team member who analyzes the portfolio construction between meetings to see where we’re taking the most risk and to make sure that it matches the area where we have the most conviction, the most upside, and the biggest alpha opportunity. At the end of the day, we have to decide whether the amount of the opportunity is worth the individual risk. We also make sure that to not place large allocation to a stock or a sector that could overwhelm performance.

The stock-specific risk is mitigated through the detailed analysis. We have a risk metric for every name relative to the other names in similar sectors and countries. Overall, we estimate the incremental risk from adding to or subtracting from a position, as well as the amount of upside and the level of conviction we have in every name. We compare that score to our other opportunities, and this is how we make our buy/sell decisions.

This process results in a broadly diversified portfolio with risks dynamically managed to reflect where we have the greatest conviction.