WITH A CALM HAND,

you reach for the mouse, call up your portfolio and click on that tech stock you bought last month the company Uncle Walt told you about, the one with that killer "artificial intelligence" app that's going to make computers smarter than

. Walt's a computer programmer, so he should know, right?

The stock, of course, has shed about 75% since you last checked about an hour ago. You read something about a class-action lawsuit over a fraudulent earnings report and insider trading, and start to think more deeply than ever about the true meaning of artificial intelligence. Your gut instinct beyond wringing Uncle Walt's neck is to pick up the phone, call the tech company's management and scream in their ears until the pain goes away.

OK, screaming might not make things better. But it would be nice to know that someone was screaming at someone, somewhere. That's where the folks at Franklin Templeton Investment's Mutual Beacon fund come in. They don't literally scream (that would be pretty rude). But when a company in their portfolio isn't performing well, they meet with management and offer helpful advice on how to run the business better.

The method seems to be working. Mutual Beacon Z shares have beaten the S&P 500 in every way you can imagine: one-year, three-year, five-year, 10 year, you name it. The fund gained 29.4% in 2003, compared with the S&P's 28.6%, and over five years it has trounced the market with a 10.3% return, compared with a loss of 0.6% for the S&P. Mutual Beacon posts such strong gains by purchasing undervalued stocks with good potential. They often help that potential along by advising management how things like share buybacks and dumping bad assets will make them look tastier to the Street.

SmartMoney.com recently spoke with Matt Haynes, co-manager of Mutual Beacon, as well as of the Mutual European fund. We asked him how shareholder activism has helped improve the fund's performance, and, naturally, we grubbed for a few stock picks.

SmartMoney.com: Can you explain your stock-picking strategy, and are you still finding value in the market after last year's run-up?

Matt Haynes: It's a three-pronged investment approach. We combine investments in what we think are substantially undervalued common stocks with distressed-debt investing and risk arbitrage. So what we're trying to do is provide our shareholders with superior risk-adjusted results over time. As it pertains to value in the market, fortunately it's a market of stocks and not a stock market, to us. Our focus is very bottom-up in nature, and in that context we're still finding plenty of areas to deploy shareholder capital.

SM: What type of stocks are good value plays today?

MH: I think what's gone up most in the recent market rally are more of the lower quality stocks. So we're finding less fair assets trading at low prices than we are finding great assets at fair prices. What we'd like to do ultimately is to be invested in companies that have great economics, strong free-cash-flow generation and a strong management team. We think more like an owner than just a passive investor. In that regard, management is a very important concern for us.

SM: One of your trademarks is that you actively engage management teams to improve their businesses. What are some of the kinds of things you try to change?

MH: We take an active approach to help the market realize what we think is a much greater full intrinsic value than it's recognizing. Most of that takes the form of private conversations with corporate management. As a result, most of our efforts aren't publicly disseminated. But oftentimes it becomes an effort in trying to help management understand what capital markets like to see. In the case of the European companies that we own, a lot of times it becomes a matter of educating the management teams as to the merits of share buybacks, divesting low-return noncore assets, using proceeds to delever the balance sheet, fairly standard things that we'd like companies to do.

SM: Any examples of successes along the shareholder activism line?

MH: There have been many examples. A lot of the companies we get attracted to as value investors tend to be very obscure companies that fall beneath the radar of most other investors. One such example is a Dutch candy company called Vanmelle it's not publicly held anymore which is the maker of Mentos, among other candies. They were this great cash-generative company trading at a single-digit multiple on earnings. Over time, we helped management to understand the merits of share buybacks, which at the time were unheard-of in Holland. They also had this small pharmaceutical business that had very little synergy with their core business. We encouraged them to sell it, and they used the proceeds to buy back stock at our suggestion. Several years later, the full intrinsic value of the company was realized in a deal as it was taken over by a privately held Italian confectioner called Perfetti.

SM: You've been known to put a lot of your assets in cash when you don't see a lot of value plays. Right now you have about 18.5% in cash.

MH: Historically, we've carried a pretty good weighting in cash because we're very opportunistic. One of our hallmarks is also doing private deals. Several things have come across our desks in the last year that have required several-hundred-million-dollar outlays. They've been very lucrative deals. If we didn't carry cash, we wouldn't necessarily be able to be as opportunistic in the past. We don't make a conscious decision about how much cash to carry, but historically we have had more cash than most funds. We have more cash today than if in aggregate the market were selling at a very cheap valuation. Today, in aggregate the market is trading near historical highs, not historical lows. If it were trading near historical lows, you would see a much lower cash balance. We focus very much on capital preservation first and capital appreciation second.

SM: Aside from the Mutual Beacon fund, you also co-manage the Mutual European fund. What's your long-term call on Europe?

MH: It's quite favorable. Europe today is several years behind where the U.S. was in terms of restructuring, and it's also a much cheaper valued continent than North America. Europe is a much less sophisticated capital market than the U.S., and therefore there's a much better opportunity to capitalize on great assets trading at big discounts to their intrinsic value. There are many companies in Europe undergoing restructuring that many companies in the U.S. have already gone through. As a restructuring many times represents a compelling value opportunity for an investor, there are many more of those restructuring opportunities in Europe than in the U.S. today.

SM: Which European stocks do you like right now?

MH: One of the top holdings in our European fund is British American Tobacco. It's one of those companies that have an excellent management team with a great track record of creating great value for shareholders over the long term. It has a very clean balance sheet, and it's a business with good economics, despite the unfavorable perception of tobacco companies. We like companies that generate strong free cash flow. Companies that generate strong free cash flow can deploy that cash in ways that will help enhance returns for shareholders. So we think you're not paying a lot for a business with great economics and a great management team.

. Why do you like it?

MH: Nestle obviously has extremely high-quality assets. And despite its mailing address being in Switzerland, most of Nestle's earnings come from outside Switzerland. We perceive Nestle as probably the best in its class trading at a very undemanding valuation. Cash-generative businesses such as food and beverage and tobacco are things that we favor a lot. Nestle today represents a globally recognized, world-class food company at a very undemanding price.

in your Mutual Beacon fund. What's the story there? It's shown strong returns over the last few years.

MH: White Mountains is a phenomenal story that's very, very underappreciated by most investors. It's a great example of a company with strong fundamentals, attractive valuations and a management team that thinks like an owner. What's great about White Mountains right now is that they've benefited from strong price increases for both primary and reinsurance risk. In the past, they've exemplified highly disciplined underwriting. They're very well capitalized. As many property-and-casualty insurers have struggled over the last couple of years, White Mountains has utilized its pristine balance sheet to acquire undervalued capital-constrained insurers. As a result, they're able to compound growth in book value on the order of 15% a year. If you can find an asset where you don't have to pay a lot for something that's going to compound your value at 15% a year, over a very long period of time it just becomes a compounding machine.