At Kayne Anderson Rudnick, risk management is fully integrated into the process of portfolio construction and portfolio monitoring. While an analytics team maintains the analytical software and provides independent monitoring, the ultimate responsibility for risk management rests with the portfolio managers. Our risk management consists of eight elements.

1. Commitment to Quality
   KAR only buys stocks that have passed our rigorous screens, survived our in-house research analysis, and passed our valuation models. Our screening process eliminates more than 95% of companies that might be in the universe of other managers.
   
   
2. Portfolio Characteristics
   We structure our portfolios to provide higher quality, superior growth (both rate of growth and consistency of growth), and better value than their appropriate benchmark. We track and report these parameters using a well-defined approach that incorporates quantitative and qualitative analysis. By regularly scrutinizing a portfolio’s quality, growth, and value characteristics in relation to its benchmark, we proactively control risk and have a history of producing superior-risk-adjusted returns. We report the quality, growth, and value parameters on our Web site, www.kayne.com. Such reporting maintains our concentration on managing risk before any focus on potential returns and this transparency allows our investors to examine how we produce our risk-return profile.
   
   
3. Construction of Sector-Aware Portfolios
   Sector-aware portfolios actively mitigate the risk of imprudent sector weighting. The sector weights of a portfolio vary to within 10% of the sector weights of its benchmark.
   
   
4. Well-Defined Sell Disciplines
   We employ a rigorous, fundamental research process to monitor continuously the growth and financial strength of a company and its industry, as well as the price of the security in relation to its intrinsic value. A stock may be sold when; (1) the target price is achieved; (2) a potential to upgrade the portfolio exists; (3) a diversification requirement exists; or (4) a fundamental negative change to the company or industry has occurred. This last criterion is a critical risk-management tool. We institute a formal written position review when any one of the following conditions exists:
   1. Stock price declines 20% or more in a short time period, absent a broad market decline
   2. Validity deteriorates for one or more reasons for purchase
   3. A deterioration in a company’s credit-quality profile
      
      
5. Analytic Software
   We use the FactSet Research Systems analytics software to monitor the relative performance and risk of each portfolio in relation to its benchmark. KAR has available on-line daily, weekly, monthly, and quarterly attribution by sector, industry, price-earnings, credit rating, stock ranking, and market capitalization. Attribution analysis allows the portfolio manager to understand and control the components of the portfolio’s relative performance and the sources of its excess return.
   
   
6. Chief Investment Officer Oversight
   The portfolio managers attend formal meetings with the chief investment officer to discuss, explain, and, if necessary, defend each strategy and its performance. This collaborative examination allows full scrutiny of each strategy's risk profile. The chief investment officer conducts a review of each holding's quality indicators. A company with a deteriorating quality profile is subjected to a formal position review.
   
   
7. Investment Compliance Committee
   The Investment Compliance Committee oversees all issues pertaining to trading and compliance. This includes, among other things, soft-dollar budgets and allocations, best execution, personal trading, and new government regulatory initiatives.
   
   
8. Due Diligence Reviews with Institutional Consultants and Wrap Sponsors
   These meetings not only permit KAR to articulate its well-defined and actively administered procedures, but also facilitate the gathering of best practices from other industry professionals

Implicit in these risk management elements is our policy of transparency regarding how we assemble our portfolios, our investment risk-return results, dissemination of third-party verification of performance calculations, and defined risk profiles. This transparency provides our clients and plan sponsors a direct and efficient means of monitoring and understanding our portfolio risk-return profile.

As evidenced by our risk-management guidelines, KAR integrates risk management into portfolio management because we believe performance can not be separated into only risk or only return. Rather, a portfolio is selected based upon the choice of a risk-return profile.

The portfolio manager is the closest to the actual risks and is the person best placed to monitor and control risk. The firm incentivizes the portfolio managers to balance risk and reward—a portfolio manager who takes extra risk, but is not rewarded by the market for it, receives less compensation. The appropriate choice of the risk-return profile is a matter of concern to each one of them.