The next part of the research process is stock selection. We look for companies on our screens which may benefit from the trends identified. Then we assess the qualitative factors, for example focusing on the quality of a corporate management team. We meet with managements either here in San Francisco, at conferences or on-site at the companies. Although not a requirement, we’ve met with the management of about 80% of the fund’s holdings.

Then we have the risk and sentiment factors. In this part of the process, risk refers to company specific risks that often involve product cycles, industry trends, trade and currency issues. Sentiment involves determining investors’ sentiment for the stock as well as consumers’ sentiment for the product or service offered. With respect to the stock, we are looking primarily at technical factors such as the flow of money in and out of the stock, or analysts’ recommendations, how many analysts are upping their estimates versus downgrading their estimates, etc. This also includes hype about a new product or service offered by a company.

The final part of our process is risk management and this specifically has to do with portfolio risk management as opposed to individual stock risk.

Q:  Can you give some examples to illustrate how you select stocks based on various trends?

A: Take the style trend, for example. Following the decision to bring more growth stocks into the portfolio, we identified companies with consistent earnings growth. In healthcare, we own a company called Fresenius SE, a German conglomerate, involved in kidney dialysis services, nutritional products and hospital management. It sells at a bit of a premium but it’s been a consistent grower and less exposed to some of the regulatory issues that other global pharmaceutical companies are exposed to. Thus in a difficult sector, Fresenius has been a very solid stock.

Another example where we made a shift from value to growth is the case of UK-based Standard Chartered Bank vs. Royal Bank of Scotland. Standard Chartered is a faster growing bank with major operations in Asia, the Middle East and Africa. RBS, a more traditional valuestyle stock, had been one of our largest holdings going into the beginning of this year, but when they joined the consortium to takeover ABN Amro that was a trigger for us to reduce the position. So, we were selling something that looked cheap and buying something which had a higher price/earnings ratio, but its growth was much more assured in the current environment.

Under infrastructure plays, we own stocks like Komatsu, an earth moving machinery company based in Japan, and Siemens of Germany with its exposure to power transmission products, automation and control systems, and communications technologies. Reinvestment in power utilities is part of the infrastructure theme in developed markets, as companies have been under-investing for nearly 40 years.

Q:  How do you build your portfolio? What is your buy and sell discipline?

A: When selecting stocks, we rank the five factors previously discussed with a value from one to five for each factor. We add up the factors and get a composite score for each stock under consideration. The stocks with the highest scores are selected for the portfolio, and the score also helps determine the weighting for the stocks. The stocks with the highest rankings are going to be the biggest holdings in the portfolio, usually around 2% or more. Other holdings range in size from about 1% to 1.5%. Ours is a somewhat concentrated portfolio with only around 75 stocks.

How much we weight a country or stock also depends on our primary benchmark, which is the MSCI EAFE Index. Because we run a core portfolio, with moderate volatility we can invest in some emerging markets, but we are limited to 20% maximum.

The ranking system also guides our sell discipline. If some of the factors start to deteriorate, the composite changes. For instance, if a stock has been performing well and valuation is less attractive, then the ranking for valuation comes down, and it triggers profit-taking on the stock. If there’s a significant management change at a company that results in us changing the management factor, the stock holding is also reduced. If we have a new idea with a better ranking than an old idea, we make a swap. If we’re trying to reduce value and introduce more growth, we look at more value oriented names for selling, and that’s part of our source of funds.

Regardless of the stock’s ranking, however, positions are tempered by portfolio risk management. That is the best way for us to monitor overall portfolio volatility.

Q:  How do you manage risk?

A: Portfolio risk management is an important part of our investment process. It involves two factors – one, maintaining a certain level of diversification and two, monitoring the volatility of the overall portfolio in order to maintain an acceptable level for our clients. As a core international large-cap type of fund, we are always exposed to international investment risks that may include liquidity levels, currency exchanges and foreign government regulations. Through diversification, we can help moderate those risks.

We use guidelines relative to the benchmark to determine the most we can overweight or underweight some of the major countries or sectors. Again, it forces us to remain invested in something that we may not like as much, but the risk of being out of it if we’re wrong could be worse than not being in it at all. That keeps our volatility lower and also forces us to constantly review the portfolio. We do this at least on a monthly basis.

As part of our review process, we use attribution analysis, basically a BARRA model to look at relative returns across countries, regions and economic sectors. In addition, our inhouse risk management technicians review the portfolio every quarter for information ratios, tracking errors, and other important metrics so we can track our performance relative to the benchmark, our peer group and our expectations. It helps identify the effects of decisions we make, and also gives an insight into the impact of not holding key benchmark stocks. Finally, we do not hedge currency exposure in the fund, but consider currency risk at the stock selection level and monitor overall currency exposures as part of our portfolio risk management process.