Armada's Bulletin Board

An Interview with Jonathan Scharlau, CFA, Portfolio Manager, Armada Small Cap Growth Fund.

With some 10 years of equity portfolio experience, Jonathan Scharlau has a unique background in a consumer marketplace – five times greater than the U.S. – that many analysts consider tomorrow's economic giant: China.

Schooled in economics at Beijing's University of International Trade and Finance, Mr. Scharlau is also conversant in Mandarin.

As China's improving investment environment continues to lure multinationals both large and small, more than 400 of the world's largest 500 companies have invested in China's lucrative markets, according to a recent report from Xinhua News Agency.

INTRODUCTION

Interviewer	You have a very intriguing background, Jon. You're competent in Mandarin Chinese and you studied economics in Beijing. Does your unique background contribute to identifying small cap multi-nationals as related to China's economic growth?
Mr. Scharlau	I certainly believe that the next decade will be the decade of China and of Asia. As portfolio manager for Small Cap Growth, Asia will be one of my areas of focus – especially from an end-market perspective; that is, companies who will profit from selling their products there. I will also look at companies that are trying to lower their cost structure by putting manufacturing facilities in China and Asia – as well as set the stage for selling their own products there at a later date. It's reasonable to assume that small domestic companies with facilities in China will present excellent opportunities to investors.
Interviewer	Could you expand more on that statement?
Mr. Scharlau	Think of semi-conductors, technology equipment and the supply-chain process. Many large manufacturers, like IBM, are expanding into China. Small companies tend to be component suppliers for those larger companies – and they have to follow their customers there. And that's where you get the investment opportunities. Many traditional companies view their future in Asia versus Europe, due to the latter's many social and governmental hurdles to business growth. Also, consider China's "law of numbers." As its economic development continues, consumer products should be an exciting area. The average Chinese consumer may use a couple of imported barrels of oil a year. If they were to move up to 10 to 15 barrels of oil to be on a par with many other developing countries, consumption would go from 3 million barrels a day to about 20 million barrels a day – eclipsing the U.S.'s 17 million barrels a day.
Interviewer	Just a little bit of a difference makes a huge impact, doesn't it?
Mr. Scharlau	Yes. I think when you look at growth rates for large cap as well as small cap companies, you're going to see a disparity between those companies that have an Asia or China strategy that works and those that don't. We think that smaller multinationals in the technology sector are particularly attractive in China.
Interviewer	Let's turn to the technology sector for a moment.

SECTOR FOCUS

Interviewer	Your portfolio puts a lot of emphasis on tech stocks: Isn't that going to make people nervous? Why are you so keen on tech stocks right now?
Mr. Scharlau	There are really two reasons. A fundamentally stronger investable universe. In the three years since the bubble burst in March, 2000, a lot of technology's excess valuation has been removed from the market. So the surviving small cap companies tend now to be very good companies. They have learned to survive and achieve profitability. Attractive valuations. Small cap growth, especially technology stocks, is cheap relative to small cap value. If the economy improves, investors will have better prospects in small cap growth.
Interviewer	What areas of technology are you interested in?
Mr. Scharlau	We're particularly interested in those companies that play a strong role in the supply chain – those companies that supply the parts and components to larger manufacturers. Many of the better companies have developed strong management teams and spent the last downturn cutting their costs and investing in their products. We also invest in technology companies with good product cycles and exciting new products like portable flash storage and flat panel displays. We're seeing strong demand for portable flash storage as consumers buy more and more digital still cameras and need to store their pictures. Likewise, as prices come down for flat panel displays, we’re seeing more computers shipped with them as consumers upgrade. When you put strong earnings prospects together with decent valuations, you can see why we’re very overweight in technology companies.
Interviewer	What else are you bullish about besides technology?
Mr. Scharlau	We're looking for growth opportunities in all areas. Our other major positions are in advertising, business services and energy.
Interviewer	Do any of your top 10 holdings – Omnivision (0.00% of total net assets as of 9/30/03), Asyst (0.69% of total net assets as of 9/30/03), Intervideo (0.65% of total net assets as of 9/30/03) and so forth – crystallize for us how your portfolio operates?
Mr. Scharlau	You have to look at all of them. They are all different: most are technology companies with different product cycles. Take Lexar Media. This is a company that makes memory media for consumer electronics like cell phones, digital cameras and digital camcorders. Lexar is successfully exploiting a trend that we touched on earlier toward greater media storage for home electronics. Only one in five U.S. households own a digital camera, and that number, as well as the volume of photos taken, is destined to rise. While Lexar is not cheap at 40 times 2004 projected earnings, we think it can go higher.
Interviewer	We spoke earlier about smaller companies following larger companies to China. In the performance world, large companies seem to follow small companies out of a recession. Why is that?

SMALL CAP GROWTH: A FLAGSHIP INDICATOR FOR EQUITY PRICES

Mr. Scharlau	Small caps tend to do worse in a recession, but tend to do better coming out of a recession, for these reasons: When the Fed stimulates the economy during a recession they lower interest rates, driving down the cost of capital for small cap companies. When interest rates become lower, general overall valuations in the market can go higher – and people take on more risk by investing in smaller companies. These companies often are small, nimble and new-product focused. They are ready to spring ahead when the economy turns up. Larger companies, on the other hand, need more time to adjust their plans and respond appropriately to new marketplace demands.
Interviewer	Small cap growth has done well this year. Does that mean it's too late to get in? Have investors missed the boat?
Mr. Scharlau	No. We believe we are entering a growth cycle that favors the small cap growth sector for at least two more years.
Interviewer	Hasn't enough money flowed into small cap growth portfolios already?
Mr. Scharlau	Those flows aren't anywhere near peak levels. There are still a lot of investors who haven't come into the market.
Interviewer	After everything the small investor has been through, isn't the average person better off investing in larger – not smaller – cap companies if they are trying to get back in the equity market?
Mr. Scharlau	If they don't have some exposure, they are missing quite a bit of what is going on in the economy. Small caps represent 75% of all stocks and since 1926, according to Ibbotson, they have provided 2% more per year than large cap companies. That's a lot of opportunity to miss. The prior three years was a very difficult period for small cap growth. We felt early this year – and still feel it – that small cap growth companies are entering a new cycle that supports them. I know it's difficult for people to invest in one of the recent past's worst performing asset classes, but I think when you look at the relative growth of what we have seen between small caps versus large caps, you are going to get better growth opportunities from small companies.
Interviewer	Let's take a look at your own Armada Small Cap Growth Fund. The objective of the Fund is targeted to more aggressive investors. That sounds like a clear signal for moderate investors to stay away, right?

A LOOK AT ARMADA SMALL CAP GROWTH FUND

Mr. Scharlau	You certainly have to have some risk tolerance to be in small cap growth companies. I'm not saying that someone should have 50% of their overall portfolio in a small cap fund, but in an overall diversified fund I certainly think that 5%-10% exposure would be good.
Interviewer	That would be tolerable for a moderate investor?
Mr. Scharlau	For a moderate person… yes.
Interviewer	How does your fund work?
Mr. Scharlau	We look for companies that grow faster than the broader market. To do that they need sustainable earnings. Such companies tend to be in better industries, are innovative, and invest in research and development.
Interviewer	Do they invest their revenue back into their companies?
Mr. Scharlau	Correct.
Interviewer	And how do you determine what's sustainable when you look at earnings in your selections? How long is considered sustainable?
Mr. Scharlau	Certainly when you look at sustainability for a small cap company, it is very different than for a large cap company, which tends to be much longer. When you look within the small cap area, sustainability can be one to two years. That's why we look at companies that are innovative, have new products – and have either fairly large market opportunities, so they can have many years of growth ahead of them, or very defensible niche positions.
Interviewer	The Fund's record looks mixed, Jon. Below par five-year performance… portfolio manager turnover. What are the steps to rectify those challenges?
Mr. Scharlau	There have been challenges. One of the solutions, hopefully, may be the 10 years of small cap experience that I brought to the firm when I joined earlier this year. Also, the team is much larger than it was in the past. I'm on a five-person team. We all have research responsibilities. Only half that number was involved in the past. Today's bench is much stronger. I also think we have a sound investment philosophy and process in place. We’re looking for good growth companies with above-average growth prospects, the ability to sustain that growth and a reasonable valuation. This year we've been finding very good companies that have strong earnings leverage that should help future performance. In the past. the Fund was very concentrated. If you are only in 40 or 50 companies, when you’re wrong it can hurt you badly. We believe in diversification. The portfolio now runs with 130 to 150 selections is diversified across sectors. You won't find us with overly large positions in any one company. Also, we manage the Fund more actively. Meaning, if a stock hits our price target and we don't see it going up – we'll sell it. Conversely, if we like a stock and we see the price coming down and our convictions haven't changed, we will add to that position.
Interviewer	Sounds like you're doing a lot of trading. Should tax-minded investors stay away?
Mr. Scharlau	We do some trading, but I would add that our turnover from trading is very similar to other small cap growth funds.
Interviewer	Let's take a moment and touch on your current Small Cap Growth Fund performance. How’s the Fund doing this year?
Mr. Scharlau	Through October 9, the Fund was up 37.8% at net asset value.
Interviewer	I'd like to take that to the bank. Keep up the good work. To wrap up, does this current economic period remind you of anything you’ve been through before? Are you experiencing any déjà vus?
Mr. Scharlau	This period reminds me of the early '90s. In my mind, there are eerie similarities: Iraq, another Bush presidency, recession, jobless recovery, etc. While no one can knows if we’re on the verge of another '90s type secular bull market, we may be closer to the beginning of a market recovery than to the end of one.
Interviewer	Thank you.

ABOUT JONATHAN SCHARLAU

Jonathan Scharlau is a member of the equity team of Armada Funds, the proprietary fund family of Cleveland-based, National City Corporation.

Prior to joining the National City Investment Management Company, he was Co-Portfolio Manager and Senior Research Analyst with US Bancorp, and a small/mid cap portfolio manager for Peregrine Capital Management.

A Chartered Financial Analyst, Mr. Scharlau holds a BA from Carleton College.

PERFORMANCE OF ARMADA SMALL CAP GROWTH FUND

Average Annual Total Returns as of 9/30/03
	Current Quarter End	Year-to-Date	1 Year	5 Year	10 Year/ Since Inception
A Shares	3.35%	19.68%	19.86%	-1.28%	-2.08%
B Shares	4.14%	20.98%	20.98%	-1.18%	-1.85%
C Shares	8.12%	24.90%	25.10%	-0.78%	-1.81%
H Shares	7.09%	23.89%	24.09%	-1.00%	-1.99%
I Shares	9.44%	26.84%	27.22%	0.09%	-0.93%
R Shares	8.55%	25.58%	25.79%	-0.46%	-1.48%

TOP TEN HOLDINGS OF ARMADA SMALL CAP GROWTH FUND (AS OF 9/30/03)

Name of Holding	% of Total Net Assets
Armada Money Market Fund	2.59
ON Semiconductor Corp.	1.16
Knight Trading Group Inc.	1.15
Labor Ready, Inc.	0.99
Macrovision Corp.	0.93
Mcdata IPO	0.90
Rowan Companies Inc.	0.90
TT Technologies, Inc.	0.90
Mesa Airlines, Inc.	0.87
Raymond James Financial Corp.	0.85

NOT FDIC INSURED, NO BANK GUARANTEE, MAY LOSE VALUE

Mutual funds involve risk, including possible loss of principal. National City Investment Management (IMC) serves as investment advisor to the Armada Funds, for which it receives an investment advisory fee. Armada Funds are distributed by Professional Funds Distributor, LLC (PFD,) 760 Moore Road, King of Prussia, PA 19406. PFD is not affiliated with IMC and is not a bank. Past performance is not indicative of future results. The performance of each class will differ due to different sales class structures and class expenses. Returns and share prices will fluctuate and on redemption, shares may be worth more or less than their original costs. To obtain a prospectus, please contact an investment professional or call 1-800-622-FUND (3863) for a prospectus. Read it carefully before you invest or send money.

Investments in smaller/mid sized companies present greater risk of loss than investment in larger companies.

As the fund is actively managed on a daily basis, the securities represented do not represent the current or future composition of the portfolio.