Where Are the Best Mid-Cap Opportunities?

Stanley Majcher is the portfolio manager of  Hotchkis and Wiley Mid-Cap Value . He recently answered our questions on the most misunderstood name in the portfolio and the extent to which competing foreign companies affect his decisions to purchase a U.S.-based company. 

3. Your portfolio is primarily domestic, with about 7% of assets in foreign stocks. To what extent does your analysis entail evaluating foreign companies that compete against U.S.-based companies you own or are considering purchasing? About the Author Liana Madura is an assistant site editor with Morningstar.com Contact Author | Meet other investing specialists An assessment of the global landscape is an important component of our industry research. As the U.S. and international economies become more interconnected, a global perspective is imperative even for domestic-based investment strategies. Many U.S.-based companies not only generate substantial revenue overseas, they have important competitors located abroad. From an investor's perspective, both of these are critical considerations when evaluating a company's business prospects and risk profile.

While less than 10% of the mid-cap portfolio is invested in companies domiciled outside U.S. borders, between 20% and 25% of the revenue generated by the portfolio's companies comes from overseas. In the mid-cap market in particular, the importance of the environment outside the U.S. varies greatly by sector/industry. Regional banks and utilities, for example, are scarcely influenced by the international marketplace. Materials, technology, industrials, and many retailers, however, are considerably influenced by the international marketplace. Research in these market segments necessitates a detailed evaluation of the global competitive landscape. This involves a determination of long-run industry margins and returns on capital. We seek to understand the factors that influence changes in supply and demand in order to determine normal industry profitability. Competitive analysis, akin to a Porter's Five Forces approach, is also evaluated to obtain a better understanding of industry risks.

The globalization of markets has been proliferating for years. In response to this dynamic, we have increased our research capacity to foster a global perspective. Five years ago, we had 14 members on our investment team--today we have 25.

4. You've proactively closed the fund at times to stave off asset bloat. What factors contribute to the decision to close the fund?We believe that limiting the assets we manage is a competitive advantage. Mutual funds with strong past performance tend to attract assets. The managers of those funds have the financial incentive to grow the assets that they manage. In cases when the firm is publicly traded or owned by a parent, there are often pressures to swell assets. When asset growth is left unconstrained it becomes difficult to invest in the opportunities that lead to the strong performance in the first place. We have witnessed some of our mid-cap peers investing in large-cap companies and/or substantially increasing the number of holdings--a dilution of resources.

We have shown a proclivity for closing our strategies at conservative levels to preserve the integrity of the process--a philosophy we are committed to going forward. Because the firm is employee-owned, we do not face the asset growth pressures of publicly traded and/or third-party-owned companies. As investors alongside our clients, our incentive is to perform.

By limiting assets, we maintain the ability to invest in a larger universe than if we were to let assets grow unconstrained. Consider a manager that has $2.5 billion in assets and wants to take a 4% position in a company with a market cap of $2 billion; the manager needs to purchase 5% of the outstanding shares. If instead this manager ran $5 billion, it would need to purchase 10% of the outstanding shares. If the manager ran $10 billion, it would need to purchase 20% of the outstanding shares. Our experience tells us that when you own 15% or more of outstanding shares, you begin to experience substantial liquidity problems and can even trigger a company's poison pill. The larger the asset size, the fewer the opportunities.

5. Many stock-pickers have been telling Morningstar that they think higher-quality stocks look relatively undervalued currently. Do you agree with that viewpoint? Why or why not?To us, the assessment of quality is analogous to our assessment of risk. Based on our definition of quality, yes, we generally agree that high-quality stocks are attractive in today's market. Another way to say this is that we are finding compelling opportunities in companies that exhibit defensive characteristics. There is not a universal definition, however, for a high-quality stock. We define a high-quality company as one with the following characteristics: durable business, strong balance sheet, enduring competitive advantage, and wise stewards of capital.

As value investors, however, we are not interested in purchasing companies that possess these qualities at any price. It is easy to make a poor-quality investment in a high-quality company--our objective is to make high-quality investments. We seek companies that are trading at attractive valuations and then conduct detailed research to determine whether the low valuation is warranted. If the company in question appears attractive but does not possess the qualities listed above, we will go on to the next idea. If the company appears attractive and possesses the qualities above, it is a candidate for purchase. In today's market, we have found that there are ample opportunities to purchase securities that possess these attributes but also trade at appealing valuations.

You should consider the Fund's investment objectives, risks, and charges and expenses carefully before you invest. This and other important information is contained in the Fund's summary prospectus and prospectus, which can be obtained by calling 1.800.796.5606 or visiting our website at www.hwcm.com. Read carefully before you invest.

Investing in medium-sized companies involves greater risks than those associated with investing in large company stocks, such as business risk, significant stock price fluctuations and illiquidity.

Mutual fund investing involves risk. Principal loss is possible.

Investing in foreign securities involves additional risks such as greater volatility and greater political, economic and currency risks and differences in accounting methods.

As of Dec. 31, 2010, Valassis Communications comprised 4.41% of the Fund's total portfolio. Fund holdings and/or sector allocations are subject to change and are not a recommendation to buy or sell any security. Information presented is based on proprietary or third-party estimates, which are subject to change and cannot be guaranteed. Diversification does not assure a profit or protect against loss in a declining market. Opinions expressed are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security.

Porter's Five Forces consists of 1) barriers to entry, 2) bargaining power of customers, 3) bargaining suppliers of suppliers, 4) threat of substitute products, 5) competitive industry rivalry. Price-to-normal earnings ratio is the current price divided by estimates of EPS in a normal environment. Earnings per share is calculated by taking the total earnings divided by the number of shares outstanding. Return on Capital measures how effectively a company uses the money invested in its operations. Poison pill is a strategic move made by a company in order to make itself seem a less attractive prospect to another company attempting a hostile takeover of it.

NOT FDIC INSURED "¢ NO BANK GUARANTEE "¢ MAY LOSE VALUE

The Hotchkis and Wiley Funds are distributed by Quasar Distributors, LLC

See More Manager Q&As

He also addressed where in his market-cap range he's finding the most opportunity and where he stands on the "quality is cheap" mantra. Finally, he discussed the benefits of periodically closing the fund's doors to new investments in order to prevent asset bloat.

1. To help illustrate your process, please discuss the most misunderstood (that is, undervalued) name in your portfolio today. What are other investors missing about it, and what will it take to unlock that value?Common sources of stock misconceptions occur when a company's prospects differ greatly from other companies in the same sector. Investors often treat sectors as a homogenous group and apply generalizations to each individual company. We believe this creates investment opportunities, particularly in out-of-favor industries because investors assume each company suffers from the same ailments. Diligent research can uncover companies that are largely immune to or can actually benefit from factors that are detrimental to the aggregate group.

We believe  Valassis Communications displayPTip('VCI', 'VCI','YTD', '', '', '', '', '', '','msg','P'); is a quintessential example of an attractive stock in an unattractive sector. The company's oldest business line provides advertisers a newspaper-based advertising medium: the free-standing insert. FSIs deliver more than 70% of the coupons used in the United States and are critical advertising vehicles for consumer packaged-goods manufacturers. Today, however, Valassis earns very little from this newspaper-based business. Because this business used to be critical to Valassis and because the newspaper industry is in secular decline, many investors assume Valassis is a business that could evaporate along with the rest of the newspaper industry. We believe the opposite is true; the company should benefit from the secular decline in the newspaper business as it shifts distribution of FSIs from newspapers to distribution through the mail at higher profit margins.

While Valassis' oldest business is its newspaper-based FSI, its mail-based business is its most profitable. Should newspapers continue their secular decline, we believe the mail-based advertising market generally, and Valassis specifically, should be the primary beneficiaries. This will likely lead to growing earnings for Valassis even though earnings for the newspaper industry should continue to decline.

In summary, we have positive outlooks on the durability of the business, the earnings growth prospects, and the ability of Valassis to buyback significant amounts of its stock. This view does not appear to be reflected in the valuation of the Valassis' stock, which trades at less than 10 times current cash earnings. Our belief is that value may be unlocked as earnings increase and investors' misconceptions about the business recede.

2. Would you say you're currently finding the best opportunities at the upper or lower end of your market-cap range these days?Subject to diversification guidelines, the portfolio's sector allocation, industry allocation, market-cap allocation, and so on are a residual of our bottom-up research process. As of Dec. 31, 2010, the portfolio's allocation by market cap is remarkably broad. Let's segment the mid-cap market into four broad buckets:

Greater than $10 billion $5 billion to $10 billion $2 billion to $5 billion Less than $2 billion

As of year-end 2010, the portfolio's allocation to each of these segments ranged from 22% to 27%. This is much more evenly allocated than is typical. Relative to the past 10 years, the current allocation is slightly biased toward the larger-cap stocks. Again, this is not result of a macroeconomic forecast favoring larger-cap stocks but a reflection of where we are identifying attractively valued securities based on our bottom-up research. In the larger segments of the mid-cap market, we find attractive opportunities in a broad array of industries: software, commercial banks, specialty retailers, and electric utilities. In the smaller segments of the mid-cap market, we also find attractive opportunities in a broad array of industries: media, freight and logistics, and apparel.

Within the portfolio, valuation differences across market capitalizations were quite consistent. On Dec. 31, the total portfolio traded at 9.0 times normal earnings. The price/normal earnings  ratio for each of the cap ranges noted above ranged from 8.2 times to 9.7 times.

It is difficult to predict whether the portfolio will have a bias toward the smaller end of the mid-cap range or the larger end of the mid-cap range going forward. Our research responsibility is segmented by industry and not by market capitalization, so we are constantly looking for ideas regardless of market-cap size. Any biases that we have are likely to be temporary and dictated by market opportunities. We are committed to limiting assets under management to protect the integrity of the strategy and to ensure that we are able to invest in attractive opportunities at the lower end of the cap range.

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Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Liana Madura does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports Bargains in Consumer... More Videos... Most Popular Related News Also in Fund Manager Q&A Managing Risk Through VolatilityA Long and Short Take on the MarketSet the Micro-Cap Bar HigherExpect More Volatility in Munis Sponsored Links Buy a Link Now Sponsor Center Please Wait... MUTUALFUNDS USA_HWMIX,USA_VCI FO_USA_HWMIX E0_USA_VCI &primaryKeyword=MUTUALFUNDS 2 {CommentWebService} OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Title Ticker Popularity Interest Premium Funds by: Title Symbol Popularity Interest Premium Articles by: Title Date Popularity Interest Independent. Insightful. Trusted. Morningstar provides stock market analysis; equity, mutual fund, and ETF research, ratings, and picks; portfolio tools; and option, hedge fund, IRA, 401k, and 529 plan research. Our reliable data and analysis can help both experienced enthusiasts and newcomers. © Copyright 2010 Morningstar, Inc. All rights reserved. Please read our Terms of Useand Privacy Policy.Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Russell 2000 quote is 10 minutes delayed. var HeaderBox = initBoxQuote("AutoCompleteBox","AutoCompleteDropDown"); HeaderBox.IdleDisplayMsg = ""; HeaderBox.LocalRegion="USA"; HeaderBox.SetPreference('USA','EN',32); var FooterBox = initBoxQuote("AutoCompleteBoxFooter","AutoCompleteDropDownFooter"); FooterBox.IdleDisplayMsg = ""; FooterBox.LocalRegion="USA"; FooterBox.SetPreference('USA','EN',32); //clears all content/image boxes-------------------------------------------------------------------------------------- var imageIDs=new Array('siteDirectoryContent', 'siteMapContent', 'productsContent'); //content boxes .mi_row3{display: none} var _gaq = _gaq || []; _gaq.push(['_setAccount', 'UA-16669347-1']); _gaq.push(['_setDomainName', '.morningstar.com']); _gaq.push(['_trackPageview']); (function() { var ga = document.createElement('script'); ga.type = 'text/javascript'; ga.async = true; ga.src = ('https:' == document.location.protocol ? 'https://ssl' : 'http://www') + '.google-analytics.com/ga.js'; var s = document.getElementsByTagName('script')[0]; s.parentNode.insertBefore(ga, s); })(); var Name = $('meta[name=DC.Creator]').attr("content").split(','); var Title = $('meta[name=DC.Title]').attr("content"); var URL = window.location.href; var Author = Name[1] + " " + Name[0]; var PubDate = $('meta[name=DC.Date]').attr("content"); _gaq.push(['_trackEvent', 'Article Title From Morningstar', Title, URL]); _gaq.push(['_trackEvent', 'Author Name From Morningstar', Author, URL]); _gaq.push(['_trackEvent', 'Article URL From Morningstar', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date From Morningstar', PubDate, URL]); _gaq.push(['_trackEvent', 'Article Title', Title, URL]); _gaq.push(['_trackEvent', 'Author Name', Author, URL]); _gaq.push(['_trackEvent', 'Article URL', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date', PubDate, URL]);

3. Your portfolio is primarily domestic, with about 7% of assets in foreign stocks. To what extent does your analysis entail evaluating foreign companies that compete against U.S.-based companies you own or are considering purchasing? About the Author Liana Madura is an assistant site editor with Morningstar.com Contact Author | Meet other investing specialists An assessment of the global landscape is an important component of our industry research. As the U.S. and international economies become more interconnected, a global perspective is imperative even for domestic-based investment strategies. Many U.S.-based companies not only generate substantial revenue overseas, they have important competitors located abroad. From an investor's perspective, both of these are critical considerations when evaluating a company's business prospects and risk profile.

While less than 10% of the mid-cap portfolio is invested in companies domiciled outside U.S. borders, between 20% and 25% of the revenue generated by the portfolio's companies comes from overseas. In the mid-cap market in particular, the importance of the environment outside the U.S. varies greatly by sector/industry. Regional banks and utilities, for example, are scarcely influenced by the international marketplace. Materials, technology, industrials, and many retailers, however, are considerably influenced by the international marketplace. Research in these market segments necessitates a detailed evaluation of the global competitive landscape. This involves a determination of long-run industry margins and returns on capital. We seek to understand the factors that influence changes in supply and demand in order to determine normal industry profitability. Competitive analysis, akin to a Porter's Five Forces approach, is also evaluated to obtain a better understanding of industry risks.

The globalization of markets has been proliferating for years. In response to this dynamic, we have increased our research capacity to foster a global perspective. Five years ago, we had 14 members on our investment team--today we have 25.

4. You've proactively closed the fund at times to stave off asset bloat. What factors contribute to the decision to close the fund?We believe that limiting the assets we manage is a competitive advantage. Mutual funds with strong past performance tend to attract assets. The managers of those funds have the financial incentive to grow the assets that they manage. In cases when the firm is publicly traded or owned by a parent, there are often pressures to swell assets. When asset growth is left unconstrained it becomes difficult to invest in the opportunities that lead to the strong performance in the first place. We have witnessed some of our mid-cap peers investing in large-cap companies and/or substantially increasing the number of holdings--a dilution of resources.

We have shown a proclivity for closing our strategies at conservative levels to preserve the integrity of the process--a philosophy we are committed to going forward. Because the firm is employee-owned, we do not face the asset growth pressures of publicly traded and/or third-party-owned companies. As investors alongside our clients, our incentive is to perform.

By limiting assets, we maintain the ability to invest in a larger universe than if we were to let assets grow unconstrained. Consider a manager that has $2.5 billion in assets and wants to take a 4% position in a company with a market cap of $2 billion; the manager needs to purchase 5% of the outstanding shares. If instead this manager ran $5 billion, it would need to purchase 10% of the outstanding shares. If the manager ran $10 billion, it would need to purchase 20% of the outstanding shares. Our experience tells us that when you own 15% or more of outstanding shares, you begin to experience substantial liquidity problems and can even trigger a company's poison pill. The larger the asset size, the fewer the opportunities.

5. Many stock-pickers have been telling Morningstar that they think higher-quality stocks look relatively undervalued currently. Do you agree with that viewpoint? Why or why not?To us, the assessment of quality is analogous to our assessment of risk. Based on our definition of quality, yes, we generally agree that high-quality stocks are attractive in today's market. Another way to say this is that we are finding compelling opportunities in companies that exhibit defensive characteristics. There is not a universal definition, however, for a high-quality stock. We define a high-quality company as one with the following characteristics: durable business, strong balance sheet, enduring competitive advantage, and wise stewards of capital.

As value investors, however, we are not interested in purchasing companies that possess these qualities at any price. It is easy to make a poor-quality investment in a high-quality company--our objective is to make high-quality investments. We seek companies that are trading at attractive valuations and then conduct detailed research to determine whether the low valuation is warranted. If the company in question appears attractive but does not possess the qualities listed above, we will go on to the next idea. If the company appears attractive and possesses the qualities above, it is a candidate for purchase. In today's market, we have found that there are ample opportunities to purchase securities that possess these attributes but also trade at appealing valuations.

You should consider the Fund's investment objectives, risks, and charges and expenses carefully before you invest. This and other important information is contained in the Fund's summary prospectus and prospectus, which can be obtained by calling 1.800.796.5606 or visiting our website at www.hwcm.com. Read carefully before you invest.

Investing in medium-sized companies involves greater risks than those associated with investing in large company stocks, such as business risk, significant stock price fluctuations and illiquidity.

Mutual fund investing involves risk. Principal loss is possible.

Investing in foreign securities involves additional risks such as greater volatility and greater political, economic and currency risks and differences in accounting methods.

As of Dec. 31, 2010, Valassis Communications comprised 4.41% of the Fund's total portfolio. Fund holdings and/or sector allocations are subject to change and are not a recommendation to buy or sell any security. Information presented is based on proprietary or third-party estimates, which are subject to change and cannot be guaranteed. Diversification does not assure a profit or protect against loss in a declining market. Opinions expressed are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security.

Porter's Five Forces consists of 1) barriers to entry, 2) bargaining power of customers, 3) bargaining suppliers of suppliers, 4) threat of substitute products, 5) competitive industry rivalry. Price-to-normal earnings ratio is the current price divided by estimates of EPS in a normal environment. Earnings per share is calculated by taking the total earnings divided by the number of shares outstanding. Return on Capital measures how effectively a company uses the money invested in its operations. Poison pill is a strategic move made by a company in order to make itself seem a less attractive prospect to another company attempting a hostile takeover of it.

NOT FDIC INSURED "¢ NO BANK GUARANTEE "¢ MAY LOSE VALUE

The Hotchkis and Wiley Funds are distributed by Quasar Distributors, LLC

See More Manager Q&As

He also addressed where in his market-cap range he's finding the most opportunity and where he stands on the "quality is cheap" mantra. Finally, he discussed the benefits of periodically closing the fund's doors to new investments in order to prevent asset bloat.

1. To help illustrate your process, please discuss the most misunderstood (that is, undervalued) name in your portfolio today. What are other investors missing about it, and what will it take to unlock that value?Common sources of stock misconceptions occur when a company's prospects differ greatly from other companies in the same sector. Investors often treat sectors as a homogenous group and apply generalizations to each individual company. We believe this creates investment opportunities, particularly in out-of-favor industries because investors assume each company suffers from the same ailments. Diligent research can uncover companies that are largely immune to or can actually benefit from factors that are detrimental to the aggregate group.

We believe  Valassis Communications displayPTip('VCI', 'VCI','YTD', '', '', '', '', '', '','msg','P'); is a quintessential example of an attractive stock in an unattractive sector. The company's oldest business line provides advertisers a newspaper-based advertising medium: the free-standing insert. FSIs deliver more than 70% of the coupons used in the United States and are critical advertising vehicles for consumer packaged-goods manufacturers. Today, however, Valassis earns very little from this newspaper-based business. Because this business used to be critical to Valassis and because the newspaper industry is in secular decline, many investors assume Valassis is a business that could evaporate along with the rest of the newspaper industry. We believe the opposite is true; the company should benefit from the secular decline in the newspaper business as it shifts distribution of FSIs from newspapers to distribution through the mail at higher profit margins.

While Valassis' oldest business is its newspaper-based FSI, its mail-based business is its most profitable. Should newspapers continue their secular decline, we believe the mail-based advertising market generally, and Valassis specifically, should be the primary beneficiaries. This will likely lead to growing earnings for Valassis even though earnings for the newspaper industry should continue to decline.

In summary, we have positive outlooks on the durability of the business, the earnings growth prospects, and the ability of Valassis to buyback significant amounts of its stock. This view does not appear to be reflected in the valuation of the Valassis' stock, which trades at less than 10 times current cash earnings. Our belief is that value may be unlocked as earnings increase and investors' misconceptions about the business recede.

2. Would you say you're currently finding the best opportunities at the upper or lower end of your market-cap range these days?Subject to diversification guidelines, the portfolio's sector allocation, industry allocation, market-cap allocation, and so on are a residual of our bottom-up research process. As of Dec. 31, 2010, the portfolio's allocation by market cap is remarkably broad. Let's segment the mid-cap market into four broad buckets:

Greater than $10 billion $5 billion to $10 billion $2 billion to $5 billion Less than $2 billion

As of year-end 2010, the portfolio's allocation to each of these segments ranged from 22% to 27%. This is much more evenly allocated than is typical. Relative to the past 10 years, the current allocation is slightly biased toward the larger-cap stocks. Again, this is not result of a macroeconomic forecast favoring larger-cap stocks but a reflection of where we are identifying attractively valued securities based on our bottom-up research. In the larger segments of the mid-cap market, we find attractive opportunities in a broad array of industries: software, commercial banks, specialty retailers, and electric utilities. In the smaller segments of the mid-cap market, we also find attractive opportunities in a broad array of industries: media, freight and logistics, and apparel.

Within the portfolio, valuation differences across market capitalizations were quite consistent. On Dec. 31, the total portfolio traded at 9.0 times normal earnings. The price/normal earnings  ratio for each of the cap ranges noted above ranged from 8.2 times to 9.7 times.

It is difficult to predict whether the portfolio will have a bias toward the smaller end of the mid-cap range or the larger end of the mid-cap range going forward. Our research responsibility is segmented by industry and not by market capitalization, so we are constantly looking for ideas regardless of market-cap size. Any biases that we have are likely to be temporary and dictated by market opportunities. We are committed to limiting assets under management to protect the integrity of the strategy and to ensure that we are able to invest in attractive opportunities at the lower end of the cap range.

Return to DiscussNext21Prev

Be Seen. Be Heard. Become a Morningstar Contributor.Reach a readership of advisors, professionals, and active investors. Submit your commentaries for publication on Morningstar.com.

Securities mentioned in this article Ticker Price($) Change(%) Morningstar Rating Morningstar Analyst Report With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds Liana Madura does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies. Video Reports Bargains in Consumer... More Videos... Most Popular Related News Also in Fund Manager Q&A Managing Risk Through VolatilityA Long and Short Take on the MarketSet the Micro-Cap Bar HigherExpect More Volatility in Munis Sponsored Links Buy a Link Now Sponsor Center Please Wait... MUTUALFUNDS USA_HWMIX,USA_VCI FO_USA_HWMIX E0_USA_VCI &primaryKeyword=MUTUALFUNDS 2 {CommentWebService} OAS_AD('Bottom'); Content Partners Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Stocks by: Title Ticker Popularity Interest Funds by: Title Symbol Popularity Interest Articles by: Title Date Popularity Interest Stock Groups by: Popularity Interest Favorites Title Fund Groups by: Popularity Interest Favorites Title Article Groups by: Popularity Interest Favorites Title Premium Stocks by: Title Ticker Popularity Interest Premium Funds by: Title Symbol Popularity Interest Premium Articles by: Title Date Popularity Interest Independent. Insightful. Trusted. Morningstar provides stock market analysis; equity, mutual fund, and ETF research, ratings, and picks; portfolio tools; and option, hedge fund, IRA, 401k, and 529 plan research. Our reliable data and analysis can help both experienced enthusiasts and newcomers. © Copyright 2010 Morningstar, Inc. All rights reserved. Please read our Terms of Useand Privacy Policy.Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. Russell 2000 quote is 10 minutes delayed. var HeaderBox = initBoxQuote("AutoCompleteBox","AutoCompleteDropDown"); HeaderBox.IdleDisplayMsg = ""; HeaderBox.LocalRegion="USA"; HeaderBox.SetPreference('USA','EN',32); var FooterBox = initBoxQuote("AutoCompleteBoxFooter","AutoCompleteDropDownFooter"); FooterBox.IdleDisplayMsg = ""; FooterBox.LocalRegion="USA"; FooterBox.SetPreference('USA','EN',32); //clears all content/image boxes-------------------------------------------------------------------------------------- var imageIDs=new Array('siteDirectoryContent', 'siteMapContent', 'productsContent'); //content boxes .mi_row3{display: none} var _gaq = _gaq || []; _gaq.push(['_setAccount', 'UA-16669347-1']); _gaq.push(['_setDomainName', '.morningstar.com']); _gaq.push(['_trackPageview']); (function() { var ga = document.createElement('script'); ga.type = 'text/javascript'; ga.async = true; ga.src = ('https:' == document.location.protocol ? 'https://ssl' : 'http://www') + '.google-analytics.com/ga.js'; var s = document.getElementsByTagName('script')[0]; s.parentNode.insertBefore(ga, s); })(); var Name = $('meta[name=DC.Creator]').attr("content").split(','); var Title = $('meta[name=DC.Title]').attr("content"); var URL = window.location.href; var Author = Name[1] + " " + Name[0]; var PubDate = $('meta[name=DC.Date]').attr("content"); _gaq.push(['_trackEvent', 'Article Title From Morningstar', Title, URL]); _gaq.push(['_trackEvent', 'Author Name From Morningstar', Author, URL]); _gaq.push(['_trackEvent', 'Article URL From Morningstar', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date From Morningstar', PubDate, URL]); _gaq.push(['_trackEvent', 'Article Title', Title, URL]); _gaq.push(['_trackEvent', 'Author Name', Author, URL]); _gaq.push(['_trackEvent', 'Article URL', URL, Title + "(by " + Author + " on " + PubDate + ")"]); _gaq.push(['_trackEvent', 'Publish Date', PubDate, URL]);

While less than 10% of the mid-cap portfolio is invested in companies domiciled outside U.S. borders, between 20% and 25% of the revenue generated by the portfolio's companies comes from overseas. In the mid-cap market in particular, the importance of the environment outside the U.S. varies greatly by sector/industry. Regional banks and utilities, for example, are scarcely influenced by the international marketplace. Materials, technology, industrials, and many retailers, however, are considerably influenced by the international marketplace. Research in these market segments necessitates a detailed evaluation of the global competitive landscape. This involves a determination of long-run industry margins and returns on capital. We seek to understand the factors that influence changes in supply and demand in order to determine normal industry profitability. Competitive analysis, akin to a Porter's Five Forces approach, is also evaluated to obtain a better understanding of industry risks.

The globalization of markets has been proliferating for years. In response to this dynamic, we have increased our research capacity to foster a global perspective. Five years ago, we had 14 members on our investment team--today we have 25.

4. You've proactively closed the fund at times to stave off asset bloat. What factors contribute to the decision to close the fund?We believe that limiting the assets we manage is a competitive advantage. Mutual funds with strong past performance tend to attract assets. The managers of those funds have the financial incentive to grow the assets that they manage. In cases when the firm is publicly traded or owned by a parent, there are often pressures to swell assets. When asset growth is left unconstrained it becomes difficult to invest in the opportunities that lead to the strong performance in the first place. We have witnessed some of our mid-cap peers investing in large-cap companies and/or substantially increasing the number of holdings--a dilution of resources.

We have shown a proclivity for closing our strategies at conservative levels to preserve the integrity of the process--a philosophy we are committed to going forward. Because the firm is employee-owned, we do not face the asset growth pressures of publicly traded and/or third-party-owned companies. As investors alongside our clients, our incentive is to perform.

By limiting assets, we maintain the ability to invest in a larger universe than if we were to let assets grow unconstrained. Consider a manager that has $2.5 billion in assets and wants to take a 4% position in a company with a market cap of $2 billion; the manager needs to purchase 5% of the outstanding shares. If instead this manager ran $5 billion, it would need to purchase 10% of the outstanding shares. If the manager ran $10 billion, it would need to purchase 20% of the outstanding shares. Our experience tells us that when you own 15% or more of outstanding shares, you begin to experience substantial liquidity problems and can even trigger a company's poison pill. The larger the asset size, the fewer the opportunities.

5. Many stock-pickers have been telling Morningstar that they think higher-quality stocks look relatively undervalued currently. Do you agree with that viewpoint? Why or why not?To us, the assessment of quality is analogous to our assessment of risk. Based on our definition of quality, yes, we generally agree that high-quality stocks are attractive in today's market. Another way to say this is that we are finding compelling opportunities in companies that exhibit defensive characteristics. There is not a universal definition, however, for a high-quality stock. We define a high-quality company as one with the following characteristics: durable business, strong balance sheet, enduring competitive advantage, and wise stewards of capital.

As value investors, however, we are not interested in purchasing companies that possess these qualities at any price. It is easy to make a poor-quality investment in a high-quality company--our objective is to make high-quality investments. We seek companies that are trading at attractive valuations and then conduct detailed research to determine whether the low valuation is warranted. If the company in question appears attractive but does not possess the qualities listed above, we will go on to the next idea. If the company appears attractive and possesses the qualities above, it is a candidate for purchase. In today's market, we have found that there are ample opportunities to purchase securities that possess these attributes but also trade at appealing valuations.

You should consider the Fund's investment objectives, risks, and charges and expenses carefully before you invest. This and other important information is contained in the Fund's summary prospectus and prospectus, which can be obtained by calling 1.800.796.5606 or visiting our website at www.hwcm.com. Read carefully before you invest.

Investing in medium-sized companies involves greater risks than those associated with investing in large company stocks, such as business risk, significant stock price fluctuations and illiquidity.

Mutual fund investing involves risk. Principal loss is possible.

Investing in foreign securities involves additional risks such as greater volatility and greater political, economic and currency risks and differences in accounting methods.

As of Dec. 31, 2010, Valassis Communications comprised 4.41% of the Fund's total portfolio. Fund holdings and/or sector allocations are subject to change and are not a recommendation to buy or sell any security. Information presented is based on proprietary or third-party estimates, which are subject to change and cannot be guaranteed. Diversification does not assure a profit or protect against loss in a declining market. Opinions expressed are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security.

Porter's Five Forces consists of 1) barriers to entry, 2) bargaining power of customers, 3) bargaining suppliers of suppliers, 4) threat of substitute products, 5) competitive industry rivalry. Price-to-normal earnings ratio is the current price divided by estimates of EPS in a normal environment. Earnings per share is calculated by taking the total earnings divided by the number of shares outstanding. Return on Capital measures how effectively a company uses the money invested in its operations. Poison pill is a strategic move made by a company in order to make itself seem a less attractive prospect to another company attempting a hostile takeover of it.

NOT FDIC INSURED "¢ NO BANK GUARANTEE "¢ MAY LOSE VALUE

The Hotchkis and Wiley Funds are distributed by Quasar Distributors, LLC

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He also addressed where in his market-cap range he's finding the most opportunity and where he stands on the "quality is cheap" mantra. Finally, he discussed the benefits of periodically closing the fund's doors to new investments in order to prevent asset bloat.

1. To help illustrate your process, please discuss the most misunderstood (that is, undervalued) name in your portfolio today. What are other investors missing about it, and what will it take to unlock that value?Common sources of stock misconceptions occur when a company's prospects differ greatly from other companies in the same sector. Investors often treat sectors as a homogenous group and apply generalizations to each individual company. We believe this creates investment opportunities, particularly in out-of-favor industries because investors assume each company suffers from the same ailments. Diligent research can uncover companies that are largely immune to or can actually benefit from factors that are detrimental to the aggregate group.

We believe  Valassis Communications is a quintessential example of an attractive stock in an unattractive sector. The company's oldest business line provides advertisers a newspaper-based advertising medium: the free-standing insert. FSIs deliver more than 70% of the coupons used in the United States and are critical advertising vehicles for consumer packaged-goods manufacturers. Today, however, Valassis earns very little from this newspaper-based business. Because this business used to be critical to Valassis and because the newspaper industry is in secular decline, many investors assume Valassis is a business that could evaporate along with the rest of the newspaper industry. We believe the opposite is true; the company should benefit from the secular decline in the newspaper business as it shifts distribution of FSIs from newspapers to distribution through the mail at higher profit margins.

While Valassis' oldest business is its newspaper-based FSI, its mail-based business is its most profitable. Should newspapers continue their secular decline, we believe the mail-based advertising market generally, and Valassis specifically, should be the primary beneficiaries. This will likely lead to growing earnings for Valassis even though earnings for the newspaper industry should continue to decline.

In summary, we have positive outlooks on the durability of the business, the earnings growth prospects, and the ability of Valassis to buyback significant amounts of its stock. This view does not appear to be reflected in the valuation of the Valassis' stock, which trades at less than 10 times current cash earnings. Our belief is that value may be unlocked as earnings increase and investors' misconceptions about the business recede.

2. Would you say you're currently finding the best opportunities at the upper or lower end of your market-cap range these days?Subject to diversification guidelines, the portfolio's sector allocation, industry allocation, market-cap allocation, and so on are a residual of our bottom-up research process. As of Dec. 31, 2010, the portfolio's allocation by market cap is remarkably broad. Let's segment the mid-cap market into four broad buckets:

Greater than $10 billion $5 billion to $10 billion $2 billion to $5 billion Less than $2 billion

As of year-end 2010, the portfolio's allocation to each of these segments ranged from 22% to 27%. This is much more evenly allocated than is typical. Relative to the past 10 years, the current allocation is slightly biased toward the larger-cap stocks. Again, this is not result of a macroeconomic forecast favoring larger-cap stocks but a reflection of where we are identifying attractively valued securities based on our bottom-up research. In the larger segments of the mid-cap market, we find attractive opportunities in a broad array of industries: software, commercial banks, specialty retailers, and electric utilities. In the smaller segments of the mid-cap market, we also find attractive opportunities in a broad array of industries: media, freight and logistics, and apparel.

Within the portfolio, valuation differences across market capitalizations were quite consistent. On Dec. 31, the total portfolio traded at 9.0 times normal earnings. The price/normal earnings  ratio for each of the cap ranges noted above ranged from 8.2 times to 9.7 times.

It is difficult to predict whether the portfolio will have a bias toward the smaller end of the mid-cap range or the larger end of the mid-cap range going forward. Our research responsibility is segmented by industry and not by market capitalization, so we are constantly looking for ideas regardless of market-cap size. Any biases that we have are likely to be temporary and dictated by market opportunities. We are committed to limiting assets under management to protect the integrity of the strategy and to ensure that we are able to invest in attractive opportunities at the lower end of the cap range.

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While Valassis' oldest business is its newspaper-based FSI, its mail-based business is its most profitable. Should newspapers continue their secular decline, we believe the mail-based advertising market generally, and Valassis specifically, should be the primary beneficiaries. This will likely lead to growing earnings for Valassis even though earnings for the newspaper industry should continue to decline.

In summary, we have positive outlooks on the durability of the business, the earnings growth prospects, and the ability of Valassis to buyback significant amounts of its stock. This view does not appear to be reflected in the valuation of the Valassis' stock, which trades at less than 10 times current cash earnings. Our belief is that value may be unlocked as earnings increase and investors' misconceptions about the business recede.

2. Would you say you're currently finding the best opportunities at the upper or lower end of your market-cap range these days?Subject to diversification guidelines, the portfolio's sector allocation, industry allocation, market-cap allocation, and so on are a residual of our bottom-up research process. As of Dec. 31, 2010, the portfolio's allocation by market cap is remarkably broad. Let's segment the mid-cap market into four broad buckets:

As of year-end 2010, the portfolio's allocation to each of these segments ranged from 22% to 27%. This is much more evenly allo Read Full Article »