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    Guest Interview:

   Rorer Asset Management, LLC

    Eight Tower Bridge, Suite 1500, 161 Washington Str.
    Conshohocken,PA 19428

    Telephone: 484-530-4300
    Fax: 484-530-3830


    Interview Quarter: 2Q1995

 James G. Hesser



Q: Jim, please tell us something about your firm and its services.

A: Rorer Asset Management is an independent Philadelphia based firm specializing in portfolio management for equity and balanced accounts. The firm was founded in 1978 by Edward C. Rorer. In 1984, Ted, as he is called, developed a highly disciplined approach to managing assets emphasizing reduced risk and preservation of capital. The investment methodology, first implemented in 1985 employs strong buy and sell disciplines designed to remove as much emotion as possible from the investment decision process. In 1990, Clifford B. Storms, Jr. joined the firm as Director of Research, bringing with him both fundamental and quantitative research experience. In 1992, I joined the firm as President, bringing to the firm 17 years of financial marketing and client service experience. Together, we have developed Rorer Asset Management into a prominent nationally recognized investment firm. Today, we boast a 10 year audited performance record which has achieved our client's investment goals with substantially less volatility than the market.

Q: What do you look for in a stock that you would characterize as contrarian?

A: While we do not characterize ourselves as "contrarians," our relative valuation work can be viewed as being somewhat contrarian in nature. Specifically, this quantitatively driven part of our work looks for those stocks that are trading below their five year historic norms on a price/earnings, price/book value, price/cash flow, price/sales and yield basis relative to the S&P 500. For example, if the stock of XYZ Inc. is currently trading at 1.0x the price/earnings multiple of the S&P 500, and its five year trading range has been 1.0x to 3.0x, our work would tag that as an attractive valuation. Of course, we look for an attractive valuation for the other four characteristics as well. We find that these stocks are, in general, out of favor with the market. Therefore this part of our discipline could be considered "contrarian" in nature.

Q: Your model uses earnings momentum as an important factor in determining stock value. Could you explain how your model works?

A: The valuation screening process narrows the original list of 1,000 companies down to about 500. The surviving list is then ranked for earnings momentum. The earnings momentum measure identifies those companies which are experiencing upward estimate revisions from the analytical community and which thereby have the best potential to provide positive earnings surprises. We use the "IBES" consensus estimates for the past 6 months to give weighting to both estimate increases and earnings surprises. This screening process narrows down the surviving list of 500 companies to about 50 to 75. We know certain things about these companies before any further work is performed. First, they have the Rorer "ideal profile," that is to say they have attractive relative valuation characteristics and are experiencing earnings momentum. Second, our experience with the modeling work has shown us that this list of companies is likely to outperform the market. So now we have narrowed our original universe down to a more workable list of approximately 50 to 75 companies and it is on this new list which we perform our rigorous fundamental research.

Q: How did this model come about?

A: The model was developed by Ted Rorer in 1984, to formalize his ideas and theories about successful investing. Throughout the early part of his career he had used an eclectic approach to investing with good results but decided that strong disciplines were needed to make the returns consistent. In developing the model, Ted was seeking a way to implement a disciplined approach to investment management. He had observed, in the early part of his career, that normal human emotions often interfere with successful decision making in the investment process. He found that in order to overcome these emotions he needed a tool which would provide guidance. The set of disciplines which were developed originated with the basic thesis that the lower a valuation an enterprise had in the market, the more attractive it was as a potential investment. While this makes intuitive sense, Ted had observed that often investors sold stocks because they had gotten caught up in the psychology of the crowd which was selling only because stocks were going down. Moreover, he observed that often investors perceived that stocks which were on the rise were perceived as being more attractive by many investors. The model which Ted developed successfully overcomes this fear and greed syndrome.

Q: Which investment factors does the model put the most emphasis on?

A: The model assigns a score to the high quality companies in the Rorer Universe based on two factors: earnings momentum and relative valuation. The earnings momentum screen identifies companies with a current history of earnings estimate increases. These companies are more likely to experience future positive earnings surprises. The relative valuation screen identifies those companies trading below 5-year normal historic valuation levels relative to the S&P 500. We feel that part of what makes Rorer unique is the fact that we emphasize "relative" value. That is to say, we can purchase the equities of any company which meets our quantitative disciplines, be it a typical value stock or a fallen growth company. This affords us the opportunity to participate in the rebound in all sectors of the economy without being forced to ride the performance cycles of either growth or value.

Q: Have you backtested this model in order to optimize its potential?

A: This model, and several variations thereof, has been thoroughly backtested. We believe the quantitative work that we perform today utilizes the most attractive elements of this extensive backtesting.

Q: Have you made any significant changes to it since then and what were they?

A: The last change of consequence was the addition of a Return on Equity discipline which we integrated into our work in 1991. This measure screens for those companies that are currently producing absolute ROE's at rates above their five year averages. Our backtests found that stocks which have attractive relative valuations, earnings momentum and above average returns on equity exhibit a greater likelihood of outperforming the market.

Q: Do macroeconomic situations ever influence your investment strategy?

A: Before purchase, every stock is considered within the total context of the portfolio as well as the economy. In addition to helping us identify attractive individual companies, the model has, from time to time, identified industries and sectors which are attractive for purchase, or conversely, ready for sale. This, in conjunction with the economic outlook of the Investment Policy Committee, helps us set the strategic direction of the portfolio. In the Fall of 1994, the model indicated that financials and other interest sensitive companies were undervalued and experiencing upwardly revised estimates, therefore we began increasing our portfolio weighting in this sector. As discussed in our Winter edition of the Rorer Review, we concluded that interest rates were peaking and would trend lower in 1995, providing a strategy to move to a maximum portfolio weighting in the financial sector.

Q: You speak of risk. How do you define and control risk?

A: We define risk as potential exposure to loss. We control it by seeking to reduce volatility in our portfolios. Industry norms measure portfolio volatility in terms of standard deviation and we endeavor to have our portfolios achieve a standard deviation that is well below the market as measured by the S&P 500. In fact, over the last five years our standard deviation has been about 25% less than that of the S&P 500. Our whole approach to stock selection lends itself to reduction of risk. In buying high quality but currently "out of favor" securities where expectations are low, we are buying equities where the downward volatility is most likely behind them. Further, because the companies we are buying are experiencing upwardly revised earnings projections, we have found that they are likely to outperform the market going forward based upon the premise that stock prices rise based on positive expectations. The way we construct our portfolios also reduces risk by limiting exposure to approximately 30-40 companies, with a 3% position, at cost, representing a "full position" for each company in the portfolio. As a risk reducing measure, a company's position is pared back once its valuation, due to market appreciation, reaches 6% of the total value of the portfolio. In addition, exposure in any single industry is limited to 20% of the total value of the portfolio and sectors are limited to 2.5X the S&P 500 weighting. Lastly, but perhaps most importantly, we find that our strong sell disciplines reduce volatility and hence risk. The biggest component of this discipline is our relative stop/loss . Simply stated, the stop/loss dictates that any stock which underperforms the market by 15% from a full position, based on the firm's average cost, will be sold from our portfolios.

Q: What ideas and people most influenced you in the development of your investment style?

A: Some of the great investors in equities have taught us that value is perhaps the most important consideration in investing. Yet many investors often forget this basic fact, basing investment decisions on "hot tips" or on price momentum. Often, then, investors perceive that a certain stock must be a great investment simply because it has recently risen in price in the markets. These investors, in a permutation of the "greater fool" theory, totally ignore what price they are paying for a company. On the other hand, the quantitative modeling work in use at Rorer focuses on value, acknowledging that the lowest risk approach is to buy companies which are out of favor where expectations are low and where a catalyst is in place for them to return to favor.

Q: What kind of analysis do you use to help you in making sell decisions?

A: The Rorer process is highly disciplined. It is an attempt to displace the emotion associated with buying and selling stock. A stock is sold when it reaches either the target price, realizing the gain in the company's value, or when the stock triggers our relative stop/loss as described above. Target prices are developed based on the fundamental analysis of the company, and are set to reflect the normal historic valuation of the company relative to the S&P 500. This valuation may be based on one or more factors, including but not limited to price/earnings, price/book, or price/cash flow. Target prices are reevaluated regularly to reflect changing fundamental economic and industry conditions. From time to time, these changing conditions may result in the reduction of the target price and/or an immediate sale.

Q: What is the average length of time you hold a stock and what is your average annual turnover?

A: On average, we expect to hold a stock for 18 to 24 months and have found that our turnover ranges between 40% and 60% a year. We consider ourselves long-term investors. Bear in mind that an extraordinary amount of effort goes into researching each company we buy and so, once we get to know a company well, we like to nurture it and watch it grow in our portfolio. However, should it become overvalued to a point where we perceive that the risk of continuing to hold it is too high, then we, of course, will sell it and seek to place the resultant funds in a more attractive opportunity.

Q: Who are the members of Rorer Asset Management and what are their investment backgrounds and functions?

A: In addition to Ted Rorer, who holds an MBA from the University of Pennsylvania Wharton School of Business, and who worked for several Wall Street firms before founding the company in 1978, Cliff Storms, our Director of Research, has been with the firm since 1990, having worked as an analyst at Value Line and a major Philadelphia bank prior to joining Rorer Asset Management. Cliff holds an MBA from the University of North Carolina in Chapel Hill and is a CFA. They are joined by Ed Stavetski and Fran Coopersmith who have built their careers as analysts and each have 10 years experience in the industry. Ed served as Director of Research for a regional brokerage firm before becoming a managing director and senior portfolio manager at a local investment counseling firm. Fran has both an MBA and a law degree. She has worked in the banking and legal industries and, more recently, as the Chief Financial Officer of a national foundation and then with a nationally recognized investment counseling firm. She is an expert in proxy law, an increasingly important part of our legal and compliance responsibilities. I round out the investment team, bringing 17 years experience with 8 of these years at Drexel Burnham and the balance with national investment management firms.

Q: Do you work as a team and trade your portfolios similarly based on group consensus?

A: Yes. The investment policy committee determines our strategy and implements it through our buy and sell decisions. Moreover, where objectives are similar, we endeavor to have our portfolios look as much alike as possible. There are several reasons for this. First, we don't like performance dispersion among our accounts. If someone signs on to the program, then they should get the program lock, stock, and barrel. Several years ago, we received very favorable publicity in the Wall Street Journal with one of our stocks, Santa Fe Pacific Railroad. Can you imagine if one of our clients had read the article and found that they didn't own the stock? We eliminate the potential for this by ensuring that our portfolios follow the "model" which, incidentally, is our own profit sharing plan. I like to say that we "eat our own cooking" because our clients own the same securities which our employees own in their own retirement plan. The beauty of this team approach to research and stock selection is that it eliminates one group of portfolios outperforming another because of portfolio manager bias. Everyone here is focusing on the same portfolio and contributing to its objectives.

Q: Where does your research come from?

A: The quantitative modeling process work starts the process and distills the large company universe down to 50 to 75 names which have the ideal profile, if you will, for further analysis. This "further analysis" entails a very rigorous fundamental look at each company under consideration. We call it "kicking the tires" and I can tell you we kick them pretty hard. We usually start by interviewing the Wall Street Analysts who follow the company closely. Following this process, we talk to corporate management and sometimes schedule a visit to the company. Further research might include talking to competitors and suppliers of the company. We do everything we can to ensure that a stock will be a good selection for our portfolios.

Q: How do you tailor your client's portfolios to meet their investment objectives?

A: At Rorer Asset Management, we work very closely with third party consultants who have structured our client's assets and determined that some portion of those assets will be best placed with an investment style such as Rorer. These consultants understand the importance of diversification and so we recognize that in these instances we are not the sole investment manager for the entire portfolio. Therefore, we believe it is critical that each portfolio follow the "Rorer approach to stock selection," and that demonstrating consistent decision making and a continual conviction toward our philosophy best meets our client's investment objectives. Of course, our ability to manage accounts with restrictions on specific securities is done from time to time utilizing a very sophisticated computer system. Clients who require lower volatility or a higher level of income find our fixed income and balanced management helpful in achieving their goals. For our balanced accounts, we use our fixed-income portion of the portfolio to help us tailor both overall risk and income requirements, and therefore the asset allocation will be varied. We try to keep our equity portion of the portfolio identical to the Rorer "model portfolio."

Q: You have consistently ranked using annualized returns in the top 25% of all managers according to Money Manager Review for the past 1, 3, 5, and 7 years. To what would you account this consistent record?

A: Achieving long-term top quartile investment performance is, first, the direct result of a consistently applied stock selection process as we have discussed with our proprietary stock selection methodology. Second, our steadfast conviction is to hire only experienced investment professionals who are committed to the "Rorer approach" to stock selection, thereby eliminating potential disruptive discourse about changing our investment style. Finally, Rorer has successfully navigated the "down periods" over the time periods mentioned; in fact our best performance relative to the market has occurred in down or difficult period in the markets. We tend to conserve capital well during the stressful times so our clients have more to work with in the ensuing good times. Over the past five years your growth of assets under management has increased several fold.

Q: Is there a limit to your size before your performance begins to suffer?

A: We don't think so. The Rorer stock selection process emphasizes mid to large capitalization companies, so we have a lot of growth ahead of us before liquidity constraints impact our trading and flexibility in the markets. As long as we continue to manage our growth effectively by attracting top experienced investment professionals through competitive compensation and ownership, and by staying current in "state of the art" back office and computer systems, the fine investment results we have been providing our clients should continue.

Q: What are the types of clients you currently serve?

A: Our clients vary from large corporate pension plans to high net worth individuals. We manage money for a variety of eleemosynary institutions, including churches, colleges, hospitals, schools and foundations. In addition, we manage funds for a variety of Taft Hartley accounts. While the majority of the money we have under management is exempt from taxation, we have a fair number of individual clients who have entrusted their personal net worth to our management. The total assets under management currently is about $600 million.

Q: Tell us a little about the Rorer Review and how it helps keep your clients informed about your investment thinking.

A: The Rorer Review is an excellent client communication piece. Ted Rorer has diligently written his quarterly strategy and economic outlook for many years. More recently we have enhanced this piece to provide sector weightings, top ten holdings, current and past performance, as well as a snapshot of portfolio characteristics. This publication has provided our clients and friends with an insight into our thinking about the markets, economic outlook, and resultant investment strategy. The "outlook" commentary has been unhedged and has produced remarkably accurate forecasts over the years. It really is a wonderful publication, and we receive many compliments about it. Client communication is very important particularly when managing equities for the long-term investor. By keeping our clients well informed they will know that we are adhering to our investment disciplines. This increases their confidence in Rorer through both good and bad times in the market.

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