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March 5, 2012

The Wall Street Transcript

Asset Mix Shifts As U.S. Economic Outlook Improves

Let me introduce my two colleagues here today. The first is Sukyong Yang. Sukyong heads our Global Core Model and International Fund at Cumberland. Sukyong joined our firm in 2009. She came to Cumberland with over 18 years of experience specializing in global equity. The second is Steve Hall. Steve joined our firm also in 2009. Steve has over 10 years of experience in investment management and works closely with me in Canadian equities.

TWST: How would you describe the firm’s overall investment approach and process?

Mr. Jackson: I’ll start off with our process and how we do things, and later talk about what we’re doing in the markets right now. Our clients follow one or more of eight models that reflect the investment mandates we offer at Cumberland. There are three key elements to our approach. First, investment decisions are process driven. Second, discipline is a key attribute of Cumberland’s success. And third, return goals are absolute, not relative.

Turning to the first element, process matters because it sets the expectation for the analyst as to what is required for successful investable ideas, helps to avoid confirmation bias through peer-relative review and it increases the frequency of good decisions. There are three stages to the investment decision-making process. The first stage is the identification stage, where we employ an intrinsic-value approach. We attempt to identify out-of-favor companies that trade at at least a 20% discount to the net present value using a discounted cash flow approach. The point of this is to establish downside risk analysis or a margin of safety, so to speak. We’re also looking to buy businesses that any competitor or private equity firm may also be interested in.

Assuming the company makes it through this screen, we’ll then assign the company to an Analyst who will conduct the deep-dive analysis. We call this the determination stage.

The second element is discipline, as I mentioned earlier, which has more to do with risk management. We employ a non-discretionary loss limit, which eliminates difficult decisions in realizing a loss. The client knows there is an absolute number where we will not tolerate any further loss of capital in a single position. We also set exposure limits on rising positions and review this at our weekly investment meetings.

Here we will do a comprehensive financial analysis, a detailed business model analysis, competitive positioning, supplier and customer checks and management visits.

In the investment decision stage, or the third stage, we conduct a peer-relative review, initially with the model investment team and then with the entire investment committee. Investment decision reports are followed up with quarterly reports that measure the progress of the investment thesis on stock positions that are put in the portfolio.

The second element is discipline, as I mentioned earlier, which has more to do with risk management. We employ a non-discretionary loss limit, which eliminates difficult decisions in realizing a loss. The client knows there is an absolute number where we will not tolerate any further loss of capital in a single position. We also set exposure limits on rising positions and review this at our weekly investment meetings.

The third element is that our focus is on absolute returns not relative to a benchmark. We are not closet indexers. In fact, we believe the less a portfolio looks like a benchmark, the more likely it will outperform the benchmark. We also believe the effect of compounding positive returns over time adds significant value.

TWST: How important is a macro view to Cumberland’s approach, and what is the firm’s overall view on the market right now, in Canada and elsewhere in the world?

Mr. Jackson: A macro view is very important. I will discuss our specific macro view as that dictates the current asset mix in our core North American equities model or mandate for clients.

One topic that came up at a recent Cumberland quarterly meeting for clients was interest rates, and currently at around 2% on the 10-year Treasury, U.S. rates are at multi-decade lows. We believe we’re close to the end of what looks like a 30-year bull market in bonds, and as a result we’re very cautious on the bond market, particularly at the long-end of the market. In times of crisis like we saw in 2008, and again in the current euro crisis of 2011-2012, U.S. Treasuries benefited from a flight to safety as investors sold risky assets and bid up bond prices. But also since 2008, central banks have intervened massively in the bond market in a quest to keep interest rates down. The Fed has continued to pump large amounts of liquidity into the economy by buying U.S. Treasuries and further distorting the natural flow of capital. The ECB has also been injecting liquidity into the system. Similarly, central banks including those of England, Japan and China have also injected liquidity. Regardless of the country, the end result is that these actions create artificial demand, and a lot of it. This, in turn, results in the increase in government bond prices and a decline in the respective interest rates.