Q:  What is your investment philosophy and how it differentiates you from other mutual funds?

A: First and foremost, we are a technical manager and we don’t rely on fundamental research. We believe that all the information available is reflected in the decision of every investor to buy, hold, or sell a stock. Therefore, all the information available is priced in the stock, and we need to monitor the price movement rather than the fundamentals.

Our goal is to build a portfolio of strong stocks that will outperform the market by an average of 4% to 6% annually and our track record indicates that we can do this. The strong buy and sell discipline is a key part of our process, because we believe that through buying strong stocks and cutting off the losers quickly, we can build a portfolio that outperforms by nature.

Our philosophy and process were developed by Robert Peirce in the late 1960s, when he analyzed the stock selection techniques of many managers with the idea that there must be a better way to invest than to simply buy Xerox or IBM, as most managers did at the time. Later, in 1984, he founded the firm together with Jane and Donald Cookson. Since then, we have enhanced our process, but the core philosophy has remained unchanged.

Q:  How that philosophy translates into an investment strategy?

A: We are an all-cap growth manager and we invest predominantly in the U.S. equity market, but we have no bias against owning the ADRs of global titans such as Sony or Siemens. Moreover, many of the U.S. companies we buy have global exposure.

In a nutshell, our strategy is to buy strong stocks, or the stocks that are outperforming the market, and sell them when they start to underperform. A crucial part of our strategy is that we let our winners run. So, when we buy a stock that does well, we continue to hold it until it underperforms. That’s just the opposite of what most individual investors do. When they buy a stock that does well, they are happy with the return, sell the winner and, therefore, miss the continued run up.

We also sell our losers very quickly, before they generate big losses. Unlike most individual investors, we wouldn’t wait and hope for the loser to recover to the price we paid. By the law of the large numbers, if you lose 50%, you need to make 100% just to get even, and we don’t want any losses that big nor do we want to wait for possibly years for a recovery.

Q:  Since you rely on relative strength, your portfolio reflects the market emotions and beliefs. Does that mean that you are actually supporting the market’s sentiment rather than questioning it?

A: We follow the market sentiment and we ride along with it. When the sentiment turns, we turn. Therefore, we’ll probably never get the very bottom or the very top in any stock. Our goal is to catch 75% of the upward move because we are waiting for a change in the sentiment to get in and out of these stocks. Typically, we are a little bit late on the buy and a little bit late on the sell, but that’s part of our process.

Q:  You mentioned that you have enhanced your system in the past decade. What improvements have you made?

A: Since the 90’s, we have added group analysis to our stock selection technique and we use 28 industry groups. The S&P 500 uses nine economic sectors in 67 groups, but we felt that nine is too few and 67 too many. Some examples of our industry groups include automotive, business services, banks, insurance, health care drugs, health care equipment, retail, real estate, and media.

We introduced those industry groups to deal with an inherent problem of the relative strength system. If you want to buy the strongest stock, which is also in the strongest group, you are typically too late. So we calculate the average alpha of the groups, and instead of buying the strongest stock in the strongest group, we buy the strongest stocks in the second quartile of groups. In that way we buy stocks in groups that are not quite recognized and overbought yet, but that still have positive momentum.

We use the industry groups to avoid groups that have been too strong. For example, right now the aerospace and defense group has been on a big run. Although we own many of those stocks, we don’t add any new ones because the group is too strong. We still don’t sell them at this point, but we aren’t purchasing them either. Overall, the group analysis keeps us from chasing stocks.

Q:  Would you explain your research process in more detail? What screens or metrics do you follow to generate ideas and sift through them?

A: Most importantly, we have a disciplined, quantitative process. We’re very much bottom-up oriented when looking at the stocks, and top-down in selecting the groups from which to purchase stocks. We regularly update our list and generate the outputs, and we select the strongest stocks to add to the portfolio from the top of that list.

If the top stock belongs to a group that is acceptable, we buy it. If we already own it, we see if there is room for buying more of that stock. If not, we move down to the next stock on the list without looking at the fundamentals. On a weekly basis, we recalculate the alpha and the beta on every stock in our universe and also recalculate group strength.

Our process is not to constantly upgrade the portfolio looking for stronger stocks than the ones we currently own. It is a ‘cast out’ process, where the sell becomes the reason for the subsequent purchase. So when a stock becomes weak and we sell it, we look for the best stock replace it with.

It is also important that we analyze our quarterly performance and adopt rectifying measures accordingly. For instance, in the third quarter of 2006 we had our worst relative performance since inception, and our analysis of this performance resulted in a change to the system. We realized that the underperformance was caused by buying stocks too long after they had been rated as buys, or near the peak as they were getting ready to weaken.

Now we move the stocks that have recently become buys to the top of our list because we know that most of the outperformance is generated early after the stock has become a buy. In addition, if stocks that we have held for more than a year have dropped down to the hold category, we sell them instead of waiting for them to drop down into the sell category. That enhancement has slightly increased the turnover, but has considerably improved our performance.