Daruma Asset Management, Inc.

Daruma invests within a clear set of rules about portfolio concentration and diversification, valuation and the sell discipline — and, most important, rules about paying attention and acting decisively when necessary:

How not to copycat the index

Own no more than 35 high-conviction holdings
Invest in a potential upside/downside of at least three to one
Invest in a potential upside of at least 50% over a two-year period
When a holding declines meaningfully, sell or buy more within 90 days
Do not manage to sector benchmark weights
Make every holding count by starting with a 2% position

How not to inflict mortal wounds on the portfolio

Know what you own
Don’t overpay
Never let any one holding grow to more than 6% of the portfolio
Own no less than 25 high-conviction positions
Cap our sectors at 25% of the portfolio or two times the Index weight, whichever is greater

The resulting portfolio combines strong return potential with risk control not dependent upon index-hugging. Portfolio turnover has averaged 40% annually since inception. Cash typically runs between 3% and 5%, and our top ten positions range between 35% and 40% of the portfolio.

A portfolio is more than just an assortment of stock picks; it becomes an ecosystem — an environment where every organism interacts with and is dependent upon every other organism. The health of the portfolio therefore must be monitored systematically, assessing risks not only at the individual stock level, but also aggregated across the entire portfolio. We always need to make sure that the portfolio has the right mix of new ideas with developing ideas as well as the right balance of risk with opportunity.

Our top ten holdings at December 31, 2010 totaled 36.7%.

Composite Top Ten Positions		Company Description
Allscripts-Misys	4.2	IT solutions for health care
First American Financial	4.1	Title insurance & settlement services
Wright Express	3.9	Payment processing services for vehicle fleets
Interface	3.7	Manufacturer of recycled & recyclable modular carpet
Shutterfly	3.6	Online photo products & services
Progress Software	3.6	Develops infrastructure software
99 Cents Only Stores	3.5	Discount retailer
AMERIGROUP	3.5	Medicaid managed care
CoStar Group	3.4	Commercial real estate information services
Bally Technologies	3.2	Manufactures & sells slot machines & software