A New Approach to Risk Management

EATHERBIE CAPITAL

COMMENTARY 2/4

EATHERBIE CAPITAL

By capturing market share, innovative companies, including those with high downside capture ratios, can potentially benefit from secular growth that may occur even during periods of economic weakness.

Even though the downside capture ratio of the Software industry was substantially higher than that of Telecommunications, Software’s high upside capture ratio resulted in strong gains on days when markets rallied during the bear market referenced in Figure 1. Those gains resulted in Software outperforming. A Better Approach to Risk Management? We believe investors should seek companies that have potential for generating earnings acceleration and revenue growth. In many instances, these companies use innovation to develop products or services that disrupt their respective industries. By capturing market share, innovative companies, including those with high downside capture ratios, can potentially benefit from secular growth that may occur even during periods of economic weakness (See Figure 2). EATHERBIE CAPITAL

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Figure 2: Innovation Prevails

130% 140% ■ U.S. Internet Ad Revenue ■ U.S. E-Commerce ■ U.S. Total Retail Sales

120%

+30% Growth

110%

100%

90%

80%

2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11

Source: Bureau of Economic Analysis, PwC, Census Bureau. *See Alger’s white paper“The Enduring Force of Innovation.”

The most innovative companies as determined by the percentage of revenues invested in research and development have transcended market volatility associated with the Great Recession and have outperformed (See Figure 3).

Figure 3: Innovative Companies Outperformed During the Great Recession (From December 2007 to June 2009)

Cumulative Excess Returns

Most Innovative

+6.3%

S&P 1500 Index

-11.5%

Least Innovative

The performance data quoted represents past performance, which is not an indication or a guarantee of future results. Source: Factset. Most/least innovative stocks excess performance is derived from highest and lowest S&P 1500 quintiles based on R&D as % of sales, normalized for market value, using one-month returns for period from 2008 to June of 2009.