TWST: At McKinley Capital Management you believe that excess market returns can be achieved through the construction and management of a diversified, fundamentally sound portfolio of inefficiently priced securities whose earnings growth rates are accelerating above market expectations. How do you implement that philosophy?

Mr. Gillam: Let me say that this philosophical statement has been unchanged for the full decade that we've been in business. The genesis of that philosophical statement, and its implementation in the marketplace, has helped McKinley Capital to outperform the S&P 500 over the last 10 years. Our All-Cap Growth Equity portfolio, for the period of 07/01/90 through 09/30/00, has numbers of 28.23% net compounded, with an S&P of 17.22% compounded. The excess returns have been remarkable.

TWST: Your performance record certainly proves the validity of your methods. Is your investment strategy complex?

Mr. Gillam: It's not as complex as it might seem. McKinley Capital believes that earnings are the key. There is a great deal of historical, academic literature on the subject which discusses the growth of earnings, but in fact, we think that it's somewhat different. We think it's the growth of the growth rate. A firm like ours looks for companies that announce earnings better than what the Street expects. Two-thirds of the time, perhaps as high as 90% of the time, the companies which we own in our portfolios announce earnings that are equal to the highest estimate on the Street, or higher. So really what it is, is the unexpected growth of the growth rate: it's a derivative, if you remember calculus.

TWST: Not fondly.

Mr. Gillam: I think we're all in that category. What it means is that companies that are doing well, companies of excellence, have a high propensity to continue to do well. We don't look in the rubble heap for good investments; rather, we look among the stars to find the superstars.

TWST: You begin the quantitative process screening a universe of 9,000 US companies, and 12,000 international publicly traded companies. I bet that has something to do with where you live and work.

Mr. Gillam: Our time zone allows us to take advantage of global markets. Before the US markets are open, our trading desk is actively trading in Europe. Between 5:30 a.m. and 12:00 p.m. Alaska time, we are trading in the US markets. At 3:30 in the afternoon Alaska time, it's 8:30 the next morning in Asia, and their trading day is just starting. It gives us an advantage to be able to trade tomorrow, today. Within our normal 12-hour workday, we can trade major markets around the world.

TWST: Tell us about the products and services you offer clients, which appear well diversified among the various investment categories.

Mr. Gillam: We started with one investment style called the Growth Equity portfolio, which is an all cap product. It has been extraordinarily successful over the last decade. What we found was that many of our institutional clients and high net worth clients would come to us from time to time and say: 'McKinley Capital, we really like that all cap product, but could you do it in the small cap arena as well? Or could you do it in the large cap arena? Or could you do it in non-US equities?' And so, the portfolios, including our alternative investment products, have been created, generally, at the request of a client. It's the same investment process, with a twist. An example would be building an automobile: from time to time you create a new model. That is what has happened for us. The philosophy that created our Growth Equity portfolio has spawned several others. We now have nine different portfolios designed specifically for a group of investors interested in a sector, capitalization range, or geographic location.

TWST: How do you go about the decisions to allocate assets to the various categories?

Mr. Gillam: Almost all plan sponsors in the United States have an asset allocation model, driven by the relationship with their consultant. The asset allocation model, typically, includes value and growth, and small to large cap, in terms of the percentage in each area. Therefore, we have built those products at the request of clients. Now, having said that, we also have found that there are some specialty requirements. For example, a year-and-a-half ago we were asked by a group of high net worth clients if we could build a portfolio that could best the Morgan Stanley High-Tech Index. We built the product, and it's just enjoyed its one-year anniversary. I believe that our net performance numbers are more than double that of the MSH Index for the same period. So it can be driven by asset allocation from an institutional area, or it can come from the high net worth clientele; in this case, we specifically focused on a sector ' the high-tech sector.

TWST: McKinley Capital does not generally fit into the traditional style boxes that most managers do. Does that continue to be the case, or do you describe your style as value or growth?

Mr. Gillam: I think our style is excess market returns over the assigned benchmark. In very general terms, I think we would be characterized as growth. What I mean by growth is that we're interested in providing to our clients, whether it's institutional or high net worth, a positive spread to the assigned benchmark. The benchmark, we have found, is irrelevant with respect to capitalization or to geographic diversity. We have finished our five-year anniversary in non-US equities and have been able to best the EAFE Index better than 2 to 1, net. At the same time, we're able to do it in the small cap arena in the United States, and in our alternative investment product arena as well. We have been very lucky.

TWST: Will you share with the readers some of the historical perspective on the quantitative investment management style as you explain it to investors?

Mr. Gillam: The quantitative investment style really began at a diverse group of universities in the United States about 30 years ago. There have been numerous articles and research pieces published throughout the last 30 years, many of which have been in your publication. It's only been in the last 15 years, however, when portfolio managers and investment managers like ourselves have had access to two things. Number one is computing power, and that occurred with the advent of the 286 computer in the mid-1980s. The second thing that occurred was the ability to have streaming databases. These are live quotations from all the markets in the world that could be digitized and put into the database. With the powerful computers that are available on the desktop, quantitative managers such as ourselves have been, therefore, able to manipulate very large databases in a very short period of time. Until 15 years ago, it could only be done at a major university such as UCLA's Anderson School, or the Wharton School, or others, that had access to large computers.

TWST: Let's move to what you are doing currently, beginning with the Growth Equity All Cap portfolio. Earlier you mentioned your concentration on earnings. How do negative pre-announcements impact your work?

Mr. Gillam: Negative announcements and pre-announcements go with the territory. It happens every quarter. They grab the headlines for the moment, but they're quickly forgotten. The vast majority of companies that are in our portfolios will not only report earnings close to the analysts' expectations, but in a majority of the cases, we think that they will report earnings at, or higher, than the highest analyst's estimates on the Street. When there is a negative pre-announcement, we have a very solid, specific, and disciplined sell process. We will not hold a security that does not meet our earnings expectations. So if we should be unlucky enough to own one of those securities that have had a negative pre-announcement, you can bet that we're also in the business of preserving our clients' capital, and typically that means we sell immediately.

TWST: Not very patient.

Mr. Gillam: Patience is something that your mother should have. In the stock market, patience is not necessarily a virtue. The reason is, in a concentrated portfolio like we manage, if you have 40 names in a portfolio, whether it's a $100 million account, or $500,000 account, the price you pay for holding on to a stock that does not perform ' this is really important ' the price you pay is that you don't get to buy the next great performing stock. It's very important to understand that there's an opportunity cost when you hold a stock that has had bad earnings for a quarter or two. It's not that there's anything wrong with that company, it's not that the management has somehow failed. What it means is that if you stay, you didn't get to buy the company whose earnings are meeting and exceeding expectations. It's an opportunity cost, it's not a vote of failure to the company.

TWST: How heavily weighted are you among the various portfolios in technology and telecom, excluding your technology portfolio?

Mr. Gillam: That's a good question because it drives to the issue of risk control. Risk control is much more important in a down market; you get very few questions about risk control in a great up-market like the fourth quarter of 1999. Further, risk control drives to the issue of sector weighting. We believe at McKinley Capital that one of the most important risk control devices is to be relatively sector neutral. For example, the Russell 1000 Growth is 50% technology. You're not going to find McKinley Capital much larger than that or much smaller than that. We are not going to be overweighted or underweighted. The reason is co- variance. You want to have stocks moving up in your portfolio, if some others are moving down. If you know that technology tends to move up and down as a sector, doesn't it make some sense to have stocks in the portfolio that are going to move the other way? It smoothes out the rough spots and it also protects you on the downside.

TWST: Apply that with a few examples.

Mr. Gillam: An example would be our Large Cap Growth portfolio, which is benched against the Russell 1000 Growth. After the recent reconstitution of the Russell 1000 Growth, the sector weighting for technology was increased to about 50%. That means that that benchmark is 50% technology. We are no more than that and, actually, are slightly underweighted in technology just now. Many growth managers would be higher than that in their technology weighting because that's where the market leadership has been. Our controls force us to buy the best stocks in each sector ' finance, utilities, health care and technology ' and not to get carried away with ourselves because all the technology stocks might look, temporarily, very attractive. Our discipline requires general sector neutrality.

TWST: So you would never make a big bet on a sector.

Mr. Gillam: We have found, historically, by making a bet like that, that oftentimes you're right, but oftentimes you're not. Our clients are interested in downside risk control and they tell us that they do not mind if a manager is down 7%, if the index is down 7%. What they do mind, however, is if you're down a multiple of that. So it's our job to outperform on the upside, but also to perform credibly on the downside.

TWST: You have many winners in your portfolios. What happens when they outperform? Do you trim or let your winners run?

Mr. Gillam: If a company were lucky enough to come up with a cure for cancer, we would never allow that company's stock in a portfolio to exceed 5%-6% weighting. No stock is so good that we put that security in our portfolios in an overweighted position. If a stock outperforms dramatically and reaches a certain weight in our portfolio, our discipline requires that we cut the stock position in half. Don't believe it if it looks too good, because oftentimes it is.

TWST: How do you spot that a company is on the way down?

Mr. Gillam: We use a process at our firm where we focus on outperformance at every level of risk. If an individual security begins to underperform at a level of risk, there's usually a reason for it. Almost always the reason relates to future earnings growth or changes in the expected growth rate. A typical example of that would be the long- distance carriers. A year ago, some of those stocks began to underperform after some period of time of outperformance. We measure that performance on a risk-adjusted basis every week, and after a number of weeks we have a specific sell discipline that takes us out of the security. We're out, not because it's a bad company, not because the management hasn't done well, but simply because there are other candidates that are doing better in the stock market.

TWST: How tax aware are you in your buying and selling?

Mr. Gillam: What we've found recently, in the last two to three years, is that our turnover has gone down significantly. We have been able to find some of the great technological changes of our time, and we stayed with them, even though there's been some volatility. As long as we have outperformance at an acceptable level of risk over a sustained period of time, we'll stay with that company. So recently, we've been quite tax efficient.

TWST: What's different about your international investment approach versus the domestic strategy?

Mr. Gillam: There are obvious things such as different accounting structures, currency issues, and different reporting cycles. Many foreign companies don't report quarterly, they report semi-annually, or they report just once a year. But aside from all those nuances, what we have discovered is that foreign equities respond to the same sorts of things that they do here in the United States. Companies will be rewarded with that 'extra' market performance if they have a string of earnings where the earnings growth rates are accelerating, such that the acceleration is under-anticipated by the market.

TWST: How do you determine your allocations to the global marketplace?

Mr. Gillam: We look at the market in the non-US environment from the bottom up, in the same way that we do the United States. We don't make macro calls. What we do is make stock calls. We buy individual securities in markets, with some limits. We won't overweight a country via a multiple to its weighting in the index. But we will overweight countries as a result of our stock-picking ability. We think that we can find good stocks throughout the world at any one time, and it really doesn't matter whether it's in Denmark, Germany, or Japan. We find that world stocks now respond to the same sorts of things that they do here in the United States ' unanticipated acceleration and a growth rate that has been underestimated by the market. Those stocks will be rewarded with extra market performance.

TWST: Are there any regions of the world where you have a concentration of companies?

Mr. Gillam: We've been overweighted in the United States vis--vis the rest of the world just recently because of the oil impact in the rest of the world. Outside the United States, the oil impact is considerably more severe than it is in our own country. Many countries, especially in Asia, have no source of fossil fuel whatsoever. Korea would be a prime example of that, where 100% of their fuel has to come in from outside sources. The last time the price of oil went to the mid-$30s, every industrialized country in the world went into recession. This is not a minor factor throughout the rest of the world vis--vis the United States. There are winners and there are losers. Oil exporters, such as Russia, have been winners; and oil importers, such as Korea, have been losers.

TWST: What are your observations about the Arctic oil fields on your doorstep?

Mr. Gillam: The oil fields are ever developing. There's an enormous amount of natural gas here, perhaps the largest natural gas deposit in the Western Hemisphere. I would guess with oil and energy resources in limited supply in the United States, that there should be both political and economic pressure to bring that natural gas to those people that need it, especially in the Midwest.

TWST: Bob, tell us, from your vantage point about investment concerns.

Mr. Gillam: I think that there are two factors afoot right now in the world that give us significant worry. Number one, since the Federal Reserve in the United States began raising interest rates some 15 months ago, there have been 130 or more central bank interest rate increases throughout the world. Those central bank interest rate increases would have, and will have, a major impact on the growth of local economies throughout the world. This is a typical process by which central banks dampen demand, keep inflation down, etc. Number two on the list, which has been unanticipated by almost everybody, is that there's another tax that's been imposed upon us all, and it represents maybe a 2.5% tax to everybody on the planet, and that is the dramatic rise in oil and energy costs. It was unanticipated. Interest rate increases around the world, in a controlled fashion by central banks, is having its anticipated effect, which is a slowing economy, slower job growth, and dampening consumer spending. The impact, however, of these dramatic increases in energy costs is what is seriously problematic to us. We think that certain economies around the world will likely slip into a recession as a result of it, and much of this has been unanticipated. While we all think the price of oil in the low $30s may be making a top, I pose the question, what if it's not? Say, the next move in oil prices is substantially higher, not lower. There is a risk around the world right now, and that is the dual risk of 130 central bank interest rate increases, plus the unanticipated 2.5% tax to every person on the planet.

TWST: Have you come to any conclusions about what's ahead for the stock market?

Mr. Gillam: A market like this, where it is not a landslide up or down, is the sort of market that our kind of firm typically really enjoys. It's easier for us to outperform in a market like this than in a wild bull market when everybody makes money. We have a very positive long- term view of world markets. There is a substantial amount of rotation going on just now, and the winners and losers will not be the winners and losers of 1999. We think that a disciplined, academic, repeatable investment approach is, perhaps, one of the only sensible ways to handle the huge volatility that one sees today around the world.

TWST: Bob, you are not what is typically understood as a black box firm. Is that correct?

Mr. Gillam: It's very important, and I think that's a great observation. We're not a black box in the sense that we don't have a computer that says, 'Buy these 40 stocks.' What our quantitative process does is nominate stocks for us. We go through the thousands and thousands of stocks, both in the United States and abroad, and we narrow it down to a very small number of stocks that are nominated for each vacancy within a portfolio. It might be only five or 10 stocks out of the thousands that get nominated. This is where the human hand takes over. We believe in having pilots in our jets: we do not believe in having drones that are run by computers. Our portfolio management team of eight portfolio managers are all working together to get the five or six stocks that are nominated down to one final candidate. It's a quantitative process which gets us down to the horses that can win the Kentucky Derby. Then we use people with an enormous amount of market experience to choose which of those horses we think will win, place or show.

TWST: One of the first steps in your investment approach, as you explain it to your clients, is structural filters. Tell us about that.

Mr. Gillam: We're very concerned about liquidity, and we screen for that. Our firm does not buy stocks that do not trade sufficient volume. We like to traffic in liquid securities regardless of markets around the world. That's a very important limitation to us. We also have a price limitation. We don't buy stocks, typically, less than $10 a share. There's a reason for that. Low price stocks do not outperform high priced stocks, historically. Our structural filters are a very important key component of our disciplined quantitative approach to providing excess returns.

TWST: Your management team's goal is to pick the right stocks for the right portfolio in any market. I wonder if you'd have any cautions for investors about what would be a wrong move as we go into 2001, and perhaps what could be a helpful move?

Mr. Gillam: I think that investors today realize that the amount of information that's available for free on the Internet is dramatically large and overwhelming, and that there's now too much information. The question is not, do you have information? The question is, what information is important? I have spent 30 years and more working on investment models that tend to focus on that part of the information stream that has an effect on future markets and future price appreciation. We are optimistic about the future of public markets around the world in the next six years. We think that the volatility is here to stay, and we think that the difference between winners and losers is that the winners will have an academic, repeatable process that they can invest exactly the same way during bull markets as they do bear markets. Remember, at the end of the day, what we're trying to do for our clients is outperform the index.

TWST: How often are you called upon to give instant commentary on the information that not only you're exposed to, but we as investors are as well?

Mr. Gillam: We tend to avoid the instantaneous commentary that's available in e-commerce these days because it's worth exactly that: not much. We would rather be more measured, more reasonable, and thought-out in our comments over the long term. In fact, we prepare research papers from time to time on issues we think are important. Our clients around the world can talk to us electronically seven days a week, 24 hours a day, or by telephone during our 12-hour work day. Clients are always encouraged to give us a call. That's why you have a private portfolio manager. You'll not talk to someone that is uninformed.

TWST: Is there anything else about McKinley Capital that we should be addressing?

Mr. Gillam: Our clients tell us there are a lot of things different about McKinley Capital. It's our measured approach, it's our discipline during good times and bad times. All I can say is, that at the end of the quarter, the year, or the decade, we'll stand on our record of performance because, really, that's what the clientele we service are interested in. Our clientele are looking for better returns regardless of the economy of tomorrow.

TWST: Thank you. (MT)

Note: Opinions and recommendations are as of 10/13/00.

ROBERT B. GILLAM McKinley Capital Management, Inc. 3301 C Street, Suite #500 Anchorage, Alaska 99503 (800) 430-8190

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