Describe your investment style (e.g. growth, value, etc.) and the types of portfolios you manage for clients.
The firm manages equity-only, balanced and fixed income-only portfolios for taxable and tax-exempt clients. Our equity style is best described as “GARP”, or growth investing at a reasonable price. Relative and absolute valuation disciplines are applied to specific companies, sectors and industries in the stock selection process. We tend to own only fundamentally superior, industry-leading companies characterized by sales, earnings and dividends (where applicable) that can grow at above-average rates. This is typically associated with established companies that enjoy conservative capital structures, financially motivated managers and employees, and proprietary products or services that provide significant barriers to entry.

Bond management focuses particular attention on capital flows, monetary conditions and economic trends. This includes monitoring the important factors that affect the economy and consequently the level and direction of interest rates. Portfolio duration and average maturity decisions are also driven by these disciplines. The investment merit of bonds is evaluated relative to that of equities in determining asset allocation for “balanced” portfolios where a particular income requirement is not specified.

Define your equity investment objectives and policies.
Equity investments are made with a long-term focus. Excessive trading that results in short-term gains or losses is not practiced, though there are circumstances when an equity position may be held less than one year. Only widely held and/or investment grade securities are owned. Once an equity investment is qualified for purchase, it is continuously evaluated relative to the factors that constituted the original investment thesis. If that combination of factors continue to be valid, the investment will be retained indefinitely within the prescribed constraints of the portfolio discipline.

Decisions regarding investment policy and security selection are made by committee through a majority vote of the investment practitioners in the firm. Once an equity investment decision is made, it is applied consistently for each client subject to the objectives and constraints of each particular portfolio. The Investment Committee meets at least monthly. The minutes of these proceedings and any evidentiary materials are retained and documented for future reference and review.

The company is committed to keeping trading costs and administrative expenses to a minimum to enhance client “net” returns. Even though we have experienced significant growth and productivity enhancements in our industry, fees and costs have actually been trending higher. Contrary to this norm, we have purposely set our management fees at the lower end of the industry spectrum which we believe will be greatly beneficial to our clients.

The investment management business requires a strict adherence to the standards of professional conduct. In addition, the company has a Code of Ethics which further defines standards of conduct and behavior for its managers, members and employees relating to the investment management discipline.

What is the most appropriate market index or indices against which your performance should be measured? If multiple indices should be used, please explain why.
It is difficult to identify a benchmark that can be used confidently to compare and contrast account performance. Each has distinct advantages and disadvantages. While the Dow Jones Industrial Average (30 stocks) and the Standard & Poor’s 500 (500 stocks) are the most common benchmarks, we feel that they misrepresent the performance of the “average” company because they include a relatively small number of stocks. In addition, most of the widely quoted indices are market-capitalization weighted. As such, the largest companies exact a disproportionate impact on each index. Since our clients’ portfolios contain large and mid-to-small capitalization stocks, we believe that much broader indices such as the Wilshire 5000, Russell 2000 and Value Line Geometric are more appropriate benchmarks.

The Wilshire 5000 is a market-capitalization weighted index which includes about 7000 stocks, all regularly traded on the New York (NYSE), American Stock Exchange (AMEX) and the NASDAQ over-the-counter market. The Russell 2000 is also a market-capitalization weighted index of stocks traded on the NYSE, AMEX and NASDAQ markets. It includes the bottom 2,000 companies from a universe of the 3,000 largest stocks in the U.S. As such, it is a widely-accepted benchmark for the mid-to-small capitalization market. The Value Line Geometric Index is an equal-weighted index of 1,700 stocks traded on the NYSE, AMEX and NASDAQ markets. Though not as broad as the Wilshire or Russell, it may be a truer measure of U.S. stock performance because it is equal rather than market-capitalization weighted.

Currently, most of our portfolios under management are balanced accounts with equities and bonds. We believe that the Lehman Municipal Bond Index is reasonably representative of the broad U.S. municipal bond market and is an appropriate benchmark for evaluating municipal bond performance in taxable accounts. In tax-exempt accounts with U.S. Treasury, Agency obligations and/or corporate bonds, we feel that the Salomon Brothers Broad Investment Grade Bond Index is a reasonably representative benchmark.

Explain why the index (indices) noted in the previous section might be considered different from your investment style or approach.
The Wilshire 5000 would be a more representative benchmark for measuring performance than would the Russell 2000 which excludes the largest 1000 stocks, many of which we own. Both the Lehman Municipal Bond Index and the Salomon Brothers Broad Investment Grade Bond Index may not be entirely reliable benchmarks for performance measurement in that their average weighted maturity and duration may be substantially different from our own. Since bond management is dynamic, obviously this disparity may widen or narrow over time.

Similarly, if a manager does not own the largest companies in a market-capitalization weighted equity index (Wilshire 5000, Russell 2000), performance may deviate significantly from the benchmark even though it may be deemed “representative” of his or her particular style. We resist the common temptation in our industry to try to mimic the performance of a particular market-capitalization index by emphasizing only the largest companies in client portfolios. Managers may be prone to less objectivity if they feel results could deviate markedly from a particular benchmark. In our experience, individual client investment goals and performance objectives may be substantially different from the benchmarks against which results are commonly measured. As such, we believe it is much more relevant to evaluate our investment expertise against these individual goals and objectives rather than solely through direct comparison to a particular benchmark where such factors such as “after-tax” results, fees and periodic withdrawals cannot be properly evaluated.

State your position on international equity exposure currently used or considered.  

A question we are frequently asked is whether it would make sense to place an increasing emphasis on emerging market investments or those economies that are experiencing higher rates of growth than the developed world? A second more nebulous argument suggests that if the U.S. and Europe may be in a phase of secular decline in relation to the
growth rates of the BRIC countries (Brazil, Russia, India and China) coupled with their expanding share of the global economic pie then wouldn’t this make the U.S. comparatively less attractive and rewarding from a macro investment perspective?

All of the data that we have read and examined conclude definitively that there is no stable or predictable relationship between economic growth rates, the size of the economy and stock market returns.[1]  These studies have examined data for both developed and emerging markets going back to 1900. 

The evidence suggests conclusively that if higher growth is already priced into those particular markets (and the stocks that comprise them) then returns are more likely to lag
rather than exceed those of the slower growth economies. It is the unexpected changes in economic and earnings growth that affect stock prices rather than the magnitude of the difference between the developed and emerging markets.  At the end of the day, valuation trumps all other considerations. As such, we conclude that a permanent allocation of a greater share of one’s investment funds to faster growing markets would most likely not be a comparatively rewarding investment strategy.

Briefly describe your process for selecting stocks.
The firm has a “top down” approach to selecting equities. Stock prices of companies in a given industry tend to move in the same general direction for multi-year cycles, irrespective of the market’s level or trend. Fundamentally superior, market leading companies tend to perform relatively better than their industry peers given their more favorable competitive positions. However, stock market leadership invariably changes over time. Experience has shown that industries and stocks that have under-performed the “averages” and current market leaders for a number of years typically outperform them in the future. An understanding of these dynamics can greatly enhance opportunities for superior relative investment performance.

The stock market tends to be very “efficient” over longer time horizons; prices will accurately reflect companies’ long-term fundamentals and intrinsic values. However, the stock market tends to be very “inefficient” over shorter time horizons. This is because short-term pricing of stocks is greatly impacted by human emotion – greed (optimism) and fear (pessimism). The prevailing fixation with short-term results by most investors can create opportunity for patient ones with a longer term focus.

Experience has shown that recent disappointments often provide fertile ground for inquiry. The task is to try to determine whether the factors impacting a company or industry are permanent or transitory and if recent price weakness represents an opportunity for long-term investment. The firm’s “sell” discipline for a particular stock is triggered by a perceived permanent change in fortunes resulting from economic, demographic or competitive trends or developments that may limit future appreciation potential or expose the client to unacceptable levels of risk for permanent capital loss.

Describe your approach to managing risk.
Systematic (market) risk is managed through our assessment of the relative risks and rewards between various asset classes (stocks versus bonds in balanced portfolios). Non-systematic (company specific) risk is managed through rigorous analysis to determine which industry groups and sectors of the economy offer the most attractive valuations, growth prospects and opportunities for long-term capital appreciation.

Diversification among sectors, industries and companies is also practiced to reduce non-systematic risk and lower portfolio volatility. Equity portfolios will typically contain from 30 to 40 individual stocks. As a general rule, each holding qualified for purchase will not exceed 3 percent of the total equity portfolio with a concentration in any one industry not exceeding twice that of the overall market “weight”.

The firm does not engage in market timing strategies. Many authoritative studies confirm that excessive trading or attempts to “time the market” are exercises in futility that can have an adverse impact on long-term investment returns. We do not utilize options, futures, derivatives or other strategies to hedge against market risk

How do you measure your ability to control risk?
Measures of risk and dispersion such as standard deviation can be derived from the firm’s management systems to help us evaluate risk on a portfolio and individual security basis where indicated or applicable.

We employ technical analysis to help us fine tune our purchase and sale disciplines for individual equity investments. Stock price action that deviates markedly from a particular benchmark or industry composite is a “flag” that requires review and evaluation relative to the original investment thesis to assess whether it should be purchased, sold or retained. The firm does not employ “targets” for purchases or sales, but does feel that technical analysis can be a valuable tool when used in conjunction with rigorous fundamental research for helping to manage risk.

Our approach identifies industries and fundamentally superior companies that have a durable competitive advantage. We prefer to make these investments when recent disappointments or short-term dislocations have already been discounted in the price. As such, the likelihood of further downside risk is greatly reduced. In our experience, some “popular” stocks with high expectations (but perhaps weak competitive positions) can be viewed as more “risky” investments if these expectations are not ultimately realized. Investors need not take extraordinary risks to achieve exceptional long term returns.

Dividend yield can also be an important element in controlling risk by helping to establish a “floor” under stock prices in a declining market environment. History has shown that cash dividends or those issued in stock are significant contributors to total return, whether paid from the portfolio or reinvested. The firm does not require that all stocks pay dividends, but does emphasize those companies that have a demonstrated history of paying regular dividends and providing consistent growth thereof. This is particularly important for those clients that require a pre-determined level of portfolio income.

Define the investment constraints appropriate to your style (e.g. market capitalization, dividend yield, stock beta).
We resist the common temptation in our industry to be labeled as having a particular “style” with respect to any constraints we might impose on our investment discipline including, but not limited to market capitalization.

What is the typical portfolio turnover rate of your accounts? Why?
The firm identifies companies with promising long-term prospects and plans to own them for a period of at least 3 to 5 years, on average. This implies an average annual portfolio turnover rate of 20 to 30 percent. The firm does not employ strategies such as “momentum” investing which emphasize short-term ownership and excessive trading in stocks with positive price action. If our assessment of an individual company or industry is correct, our clients should be commensurately rewarded over a period measured in years, rather than months or quarters. We also make a conscious effort to minimize commission costs and capital gains taxes which can have an adverse impact on client “net” returns.

Against what standards would you consider it appropriate for your services to be terminated, specifically considering investment performance and/or straying from your defined style and objectives?
All fee-paying clients are encouraged to complete an Investment Policy Statement (IPS) with the assistance of the firm. This is an important and useful document because it provides an objective basis against which the professional relationship can be evaluated. The IPS is designed to be flexible, yet specific and can be tailored to address such issues as asset allocation, low basis stock, frequency of communication, contributions and withdrawals and performance expectations or benchmarks. Clients are encouraged to review the IPS with the firm at least annually and make any revisions that they feel are mutually acceptable or appropriate. Should the manager stray from the prescribed guidelines or not meet the long-term performance objectives, this would constitute valid grounds for dismissal.

Would you be able to direct trades to specified broker dealers for purposes of soft dollar arrangements?
We currently have no soft dollar arrangements and believe that they can lead to potential conflicts of interest. The firm will direct commissions to a particular broker(s) when instructed to do so by the client. In these instances, the client should be aware that 1) higher commissions may be incurred due to our inability to negotiate, 2) the client may not benefit from volume discounts that might otherwise be obtained when transactions are combined with orders of other clients and 3) the execution of all trades by a particular broker(s) at the client’s instruction may or may not result in the best execution for specific transactions.