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September 30, 2003

Hedgies for the Pros

By Kathryn M.Welling

Well, we have 1,100 stocks in our North American universe and the market is up 20 percent year to date, even more off of the bottom. Yet I could give you the names of 200 of our stocks that are down, probably by more, during that same timeframe. My point is that those are the stocks a stock picker should focus on. Why they are down is what we are supposed to unearth and figure out. We basically believe that companies with improving earnings momentum that trade at a discount to their region and sector tend to outperform, while companies with deteriorating earnings momentum that trade at a premium to their region or sector tend to underperform. Our expectation is that by blending cheap stocks with improving earnings momentum with expensive stocks with deteriorating earnings momentum in a balanced global/long/short portfolio, we should be able to capture the performance spread between those two types of companies - while at the same time controlling the amount of risk we're assuming. And without having to make a directional bet on the market. That's why I come down on the side of being directionally neutral.

If it's a close call, maybe, fine. But if your research leads you to believe the market's heading one way or the other, why not try to enhance your returns?

It comes down to a question of risk. Of course, I have my own biases and my judgments - and I actually act on those in my personal account - but for an institutional product I think the answer is minimal directional bias, which translates into zero correlation with the S&P 500 and the MSCI world. And that's what we have: Zero correlation.

Zero - under normal circumstances, you mean? The market has a way of making a mess of the best-made plans-

You are absolutely right. There are always the exogenous forces at work. It's just that you have to use what tools you have.

At any rate, except that you now balance your longs with shorts, Avera's approach doesn't differ a whole lot from what you did for 10 years at Montgomery Asset?

Not much at all. I've got multiple analysts at Avera gathering lots of data points and communicating what they find efficiently among one another. That is how we start to generate conviction and ideas; how we start to see trends that aren't reflected in stock prices yet.

And this data is essentially about earnings expectations? Even though analysts' forecasts have been pretty thoroughly discredited since the bubble popped?