MICHAEL J. MOODY, Vice President and Senior Portfolio Manager at Dorsey Wright Money Management, began his securities career as an account executive at Merrill Lynch in 1984. He moved to Smith Barney in 1987 and rose to the level of Senior Portfolio Manager before leaving to join Dorsey Wright & Associates in 1994. More

TWST: Would you please start with an overview of Dorsey Wright and your respective responsibilities there?

Mr. Moody: Dorsey Wright was founded in 1987. The home office is in Richmond, Virginia, and all of the publications are done there, including a daily equity report that goes out to a variety of member firms, brokerage offices, bank trust departments and investment advisers. It’s principally a professional product, although there are some individual subscribers. The money management arm that I, Harold Parker, John Lewis and Andy Hyer are part of is in Pasadena, California. We started in 1994, and Dorsey Wright Money Management now manages about $400 million using relative strength as the core methodology. Our account base is a mixture of separate accounts, the Arrow DWA Balanced Fund and the Rydex Dynamic Advantage mutual fund wrap program, and it will soon include a Technical Leaders Portfolio, which is an exchange-traded fund sponsored by PowerShares.

TWST: What is the investment philosophy of Dorsey Wright Money Management?

Mr. Lewis: We do something different from most other firms on the Street. We look at technical data, and we do very, very little fundamental work here. What we are looking at is not what we think stocks should be doing, but how they are behaving in the marketplace. By doing that, we are finding stocks that are actually performing well regardless of our opinions and biases. We are strength followers, and our approach is very systematic and trend following in nature.

TWST: Your methodology of systematic relative strength is an interesting concept. Would you expand on how you adapt it to your stock selection?

Mr. Lewis: Relative strength is a measure of how strong an individual stock is versus a common market benchmark, like the S&P 500 or a universe of stocks. We’re putting together portfolios of stocks with very good relative strength characteristics. We are building portfolios of stocks that have been strong over the past year or six months or so, but we apply it in a very systematic and disciplined fashion. It is very similar to a quantitative type of model, but there are no fundamentals involved. We’re not looking at accounting data or anything like that; it is purely relative strength, which is very, very objective. The other thing that we really like about relative strength is that it allows the portfolios to be extremely adaptive. We’re just using market price data to position the portfolios in whatever is working in the marketplace at any given time, and that is really what makes it so adaptive and robust over time.

TWST: Would you describe your portfolio construction process and what goes into the actual decision-making?

Mr. Lewis: When we are putting together the individual stock portfolios, we look at them from two sides. We have a top-down model, which looks at 10 economic macro sectors and 65 industry groups. We look for overall major trends. So in the late 1990s, our type of model would identify technology, biotechnology and sectors like that as leadership, and in 2005, it would include things like energy and utilities. That top-down model is looking to identify the broad areas of strength in the market. Then we have a stock selection model, which is based on relative strength, where we are ranking our universe of stocks day by day and putting the strongest stocks from the strongest macro sectors into the portfolio. So the bottom-up model selects the individual names for the portfolios, but we are selecting those names from the strongest areas of the market.

TWST: How many names are there in the portfolio? Does that number fluctuate?

Mr. Moody: Yes. We run about 20 to 25 stocks, so it is a concentrated portfolio, although it is diversified over many macro sectors. But we are not forced to be in any macro sector, and we are not benchmarking against an index at all, so we are not trying to mirror different industry allocations or macro allocations. We will be out of a macro sector if it is not working at all, and we might take substantial overweights in macro sectors that are working very well.

TWST: Do you have an index to measure your performance?

Mr. Lewis: We benchmark to the standard S&P 500 Total Return benchmark, but what we do is not very well correlated with that Index. We use that over a full market cycle to compare our performance to, but from day to day, week to week and quarter to quarter, our methodology can deviate significantly and become uncoupled with that benchmark.

Mr. Moody: Yes, we can have a substantial lack of correlation with the S&P 500 over shorter time periods, given the methodology. It follows themes; in 2005, for example, it was very heavily weighted in energy, much more heavily than the S&P, and was out of some areas completely. It ended up looking a lot different than the benchmark, but the performance turned out to be very good as a result.

TWST: What are the different types of portfolios that you offer to clients? Are the styles different, even though they all have systematic relative strength?

Mr. Moody: We have several account objectives, and we try to match these to client objectives, depending on their particular situation. There is a Systematic Relative Strength Aggressive model that has somewhat more volatility and potentially higher returns. There is a Systematic Relative Strength Core model, which gives the stocks a little bit more wiggle room before they get pushed out, so the turnover is a little lower. Then we have a Systematic Relative Strength Conservative model, which is a balanced portfolio composed of core equities and intermediate bonds in roughly a 60-40 mix.

TWST: Do you have an international portfolio?

Mr. Moody: We do; it is a separate item. It is available at selected firms, and that portfolio uses a universe of American Depositary Receipts and US-listed foreign equities. The benchmark there is a little different. We use EAFE total returns, but it’s the identical concept — just applied to a different universe of securities.

Mr. Lewis: We are much more interested in how the stock is performing in the marketplace than we are in the actual company. We are not doing in-depth fundamental research; we go strictly by the relative strength factor that we know is very robust over time. In 2005, we were very heavily weighted in energy. That came out of the portfolio during 2006. We are not seeing a whole lot of overall macro sector leadership at the moment, so our portfolios from that standpoint are more equal weight than they have been for some time. We have been seeing some new adds in the technology area. Our financial exposure has come down a little bit, and we have also seen a pickup in the consumer cyclical area and have been adding names in that area as well.

Mr. Moody: It is not so much that any one company’s fundamentals attract us — it is the strength in the sector and the stock’s own relative strength that have appeal. So as we see energy waning, that area tends to get cut back and positions get added into the areas that are getting stronger. For a while in the spring, it was financials, so we had a fair representation in things like real estate investment trusts and insurance, and more recently, it has gotten more spread out to where there is no clear macro sector leadership — just a broad, diversified portfolio with fairly even sector weights.

TWST: What triggers an exit from your portfolios?

Mr. Lewis: The sell discipline in the portfolios is rules-based, and it is a mechanical process for us. Every day, we are ranking our universe of stocks based on relative strength, and when a stock hits a level in our rankings that we know is an unacceptable ranking, it is automatically kicked out of the portfolio. It’s very simple, very mechanical, and there is really no discretion on the sell side from the portfolio management decision standpoint. It hits that level on the ranking system, it is automatically kicked out, and we look for something on the buy side in a stronger macro sector.

TWST: What is the average turnover in your portfolios?

Mr. Moody: Morningstar says that the average domestic equity mutual fund turnover is about 130% annually. Our aggressive portfolio averages about 120% annually; it can range from roughly 100% to 150% in any given year. The core portfolio has a little bit less turnover. It averages around 75%, and it can range from 50% to 100% in a given year. One of the interesting side benefits of relevant strength is that it tends to let the winners run and cuts the losers short. So the turnover turns out to be relatively tax efficient, because almost all of the realized net gains taken in any given year tend to be long-term capital gains, which are taxed at a more favorable rate.

TWST: How do you attempt to control risk in the portfolios and in the securities?

Mr. Lewis: The risk is controlled in two ways. One is the sell discipline on the individual equities. When they start to lose strength and reach a ranking that is unacceptable, they are kicked out and we look for another name. That is the bottom-up part of the process. From a top-down perspective, we also have the overall macro sector overlay, which helps us to avoid areas of the market that, as a group, are not performing well. So the 2002 model just avoided technology, and we didn’t have any weight there. Those are the two ways that we control the risk in the portfolio.

TWST: Has the Systematic Relative Strength approach been a long-going process or is it a relatively new approach to investing?

Mr. Moody: The development work has been going on for a long time. Harold Parker and I wrote an article for Technical Analysis of Stocks & Commodities on point and figure relative strength in the early 1990s. Over the course of the last 10 years or so, we have been continuing to quantify relative strength. When John arrived, our ability to do quantification and testing took a quantum leap forward, and today, we have a very systematic process. So there has been an evolution in our case. In terms of technical analysis, relative strength has been an extremely well- known and well-tested technical factor that has been written about since the early 1900s. So the factor itself is not new. Our particular approach to it is maybe a little bit unique to us because of our background. All three of the Portfolio Managers here are Chartered Market Technicians. That is maybe a little bit different from a firm that starts from a fundamental perspective with a group of Chartered Financial Analysts.

TWST: Would you tell us more about your research team?

Mr. Moody: We have four people in this office, and all four of us are Chartered Market Technicians. That is a professional designation in technical market analysis that is awarded by the Market Technicians Association. Over the years, we have been involved with both the Market Technicians Association and the American Association for Professional Technical Analysts. It is just a different way of looking at the market. We’re not so concerned with searching out undervalued things; we’re more concerned with seeing what is performing well now. It makes it easier to quantify. The data set is cleaner and less emotional. Those are just some of the advantages to taking a more systematic, technical and quantitatively oriented approach to things.

TWST: In what other ways is your investment approach distinctive or differentiated from other firms? What are you bringing to the table that others might not?

Mr. Lewis: It is a very disciplined process that is focused on what is working, not what we think should be working. We’re not doing any forecasting; we’re not talking to company management. We are solely focused on positioning the portfolios in areas of the market that are currently working. Whether people think they should be working or not is irrelevant to us — we go where the strength is and we follow it in a very disciplined fashion. That is a very, very different approach from what most firms out there take. Most firms are very concerned with fundamentals and companies. We don’t look at any of that. We are much more concerned with stocks. Relative strength is the only factor in the decision-making process.

Mr. Moody: I think the lack of forecasting is key. In many cases, trends that have run for some time are very powerful. Forecasting is a guess that there will be a reversal of that trend. The real estate investment trust area is a very good recent example. That has been a strong area for many years now, but each year after the initial strength, some analyst would say, We think REITs are too extended and will pull back. The REITs have another good year and then another analyst pops up and says that they are way overvalued, and that they will pull back, yet they proceed to have another good year. Trends can go on for much longer than people think, so we try not to forecast when these trends end. I think having a trend-following methodology rather than a forecasting methodology is fairly unique in the equity market.

TWST: Do your portfolios perform equally well in up or down markets?

Mr. Moody: The testing we have done indicates that the portfolios are somewhat more volatile than the overall market. So in an up market, they tend to outperform, and in a down market, they sometimes lag a little bit. But like we said earlier, they are not always very correlated. There are periods where the S&P 500 may go down and these portfolios go up. The other thing we have noticed over time is that although they have performed relatively well during value cycles — like we have had for the last five to six years — they tend to perform extremely well in growth cycles. At some point, we will switch from the value cycle we are in back to a growth-oriented cycle, and when that happens, we would expect performance to improve even beyond where it has been in the last couple of years.

TWST: What advice would you give to investors who are interested in this systematic relative strength approach?

Mr. Moody: The most important advice is to do thorough due diligence. This would apply to our approach by understanding what it is you’re getting into, what the characteristics are in terms of performance, and then sticking with your decision. Far more damage is done to individuals by putting money with managers at inopportune times and pulling money out at inopportune times. There are numerous academic studies that show that most investor problems are self- inflicted. If the due diligence is done thoroughly and a comfort level is reached, investors can stick with their decisions through thick and thin. They will know that they made a good decision because they did the background work. That is probably the most important advice for anybody.

TWST: What is the investment environment like for your type of investing?

Mr. Moody: We have had a good start to this year. We manage a mutual fund that has a variety of asset classes in it, and the fixed income asset class, for example, is not at a full weight in that model — the model prefers equity, especially international stocks. So the outlook for equity markets still appears to be relatively good, and both domestic and international equities should perform well. It looks like the international equities might even have an edge after having had a very good year last year.

TWST: Do you see any challenges ahead or possible problem areas?

Mr. Lewis: There are always challenges out there. I think there is still a lot of uncertainty about the direction of the economy and where interest rates are going. That is the challenge for most people at the moment. With the way our portfolios are positioned, we are very adaptable if rates change or things in the economy change — that will all be reflected in price. It will flow through to our relative strength factors, and we will reposition the portfolios accordingly. Lack of leadership is generally the biggest challenge for us. When there is good sector leadership, very good trends tend to be in place. Hopefully, we will get that this year. If we see more uncertainty, then we will have to reposition the portfolios accordingly.

Mr. Moody: In any given year, there are things that come up, and it is always a mistake to try to forecast how those things will impact the market. There is an often-repeated belief that interest rates coming down helps equities, but from 2000 to 2002, rates came down and equities suffered a very severe bear market. There was a belief that rising rates couldn’t be good for equities, but rates rose from the bottom in 2002 through the beginning of this year, and we continued to have a relatively robust equity market. So although the challenges are always out there, it is a mistake to assume that the market is going to respond to them in certain ways. That’s why we prefer a systematic model-based approach to do the adaptation, rather than guessing at what might happen. It is always surprising what happens in real markets. According to finance textbooks, there are certain things that just should not happen, but they happen in real life all the time.

TWST: Thank you. (PS)

Note: Opinions and recommendations are as of 1/23/07.

MICHAEL J. MOODY HAROLD B. PARKER JR. JOHN LEWIS Dorsey Wright Money Management 595 East Colorado Blvd. Suite 307 Pasadena, CA 91101 (626) 535-0630