Another day, another record high. What’s not to like about this US equity rally?
Quite a lot, actually, for many portfolio managers.
In the past 12 months the S&P 500 has risen around 6.5%. It is hard enough to outperform for large-cap growth managers who, despite rising with the tide, have seen hundreds of billions flow out to passive strategies in the past 12 months.
As stock prices rise, despite some suspect fundamentals, the buying opportunities for these managers become ever more limited. Meanwhile, their performance looks poor by comparison.
The only reason we had any money left is because investors forgot they had money with me. Nothing went wrong, I just wasn’t willing to play the internet game. I wasn’t willing to buy all these companies that were trading at up to 20 times revenues
Still, being out of fashion, favor or flows has never bothered Romick before and it seems unlikely to bother him now.
He has remained unshaken in the face of far worse.
During the late 1990s Romick refused to buy into any of the tech companies driving the dotcom boom. This led to a lag in performance and significant outflows. The fund’s assets fell from $281 million in the second quarter of 1998 to $33 million in the fourth quarter of 2000.
‘The only reason we had any money left is because they [investors] forgot they had money with me,’ he says.
He laughs now, but is quick to add: ‘It was distressing. At the time it was very traumatic.
‘Nothing went wrong, I just wasn’t willing to play the internet game. I wasn’t willing to buy all these companies that were trading at up to 20 times revenues.’
Romick's fund beats the manager average in his category, though the index has proved tough to match
Value investing is less a style and more a way of life for the Los Angeles-based manager.
‘Being a value investor, it’s something you either are or you aren’t. Many people aren’t,’ he says.
‘Value stocks in the US have underperformed. In the last seven years value has only outperformed in one of those years. Value investing is out of favor.’
By his own admission the Crescent fund would have performed better since 2013 if he and his fellow managers had not traded once.
Has this, or his experience in the late 1990s, ever made him question the way he invests?
‘No, I’ve never questioned it, not even once,’ he states. ‘I’ve never been shaky about it.
‘Our goal is not to beat the market, it’s to do as well as the market over time but with less risk. We have been able to accomplish it over the long term and do it over market cycles.’
‘We spend a lot of time educating our shareholders. We spend a lot time explaining what we do and how we do it. We write long letters, have investor days, write commentaries. We try to educate.’
Romick’s belief in value investing is not based on blind faith but rather fundamentals.
It is this focus that makes him question the current S&P 500 rally and back his own portfolio.
‘The S&P 500 has had declining earnings year-on-year for seven consecutive quarters and the stock prices have moved higher,’ he says. ‘In our portfolio, on the other hand, we’ve had earnings growth up year-over-year, but our stocks on average are down slightly. I don’t know why.
‘The projection for our earnings is greater than the market. I don’t know if that is going to come to pass, but if you have something that is cheaper on a price-to-book basis, cheaper on a projected price-to-earnings basis, and it exhibits earning growth then wouldn’t you rather own that than the alternative, which is more expensive but not making more money year-over-year?
‘Yes, but that’s not the way the market is pricing things today.’
Total net assets: Flows into the FPA Crescent fund picked up from 2010 onwards although have slowed down slightly in the first two quarters of 2016
From banks to brokers
The FPA Crescent fund has the ability to invest wherever it wants across assets classes, geographies and market capitalizations.
It is currently 34% cash due to the lack of value Romick perceives in the market. This has been as high as 45% in the past.
But Romick has been buying over the last year. He has built up a position in lenders, including Bank of America Merrill Lynch, Citi Group and CIT Bank, which combined account for 15% of the fund.
‘They trade at deep discounts to where they have historically and they have better balance sheets than they have had historically,’ he says. ‘A year ago we didn’t have anything like that.’
In the past 12 months he also bought stakes in broker-dealer LPL Financial, Russian retailer Lenta, Chinese internet service company Baidu and US chemical distributions firm Nexeo Solutions.
He has also spied some opportunities in high yield, although he is not entirely happy with the returns on offer from this asset class.
‘High-yield bonds are like vacation homes, you go to them when the weather is nice. In this case, by nice we mean stormy.’
Be this as it may, high yield now accounts for around 5% of the fund, up from 1% a year ago, as he bought into debt from metals, mining and energy companies. These include bonds issued by natural gas and coal producer Consol Energy as well as Glencore Funding, the financing division of commodities giant Glencore.
He would like high yield to account for as much as 12% of the portfolio but is looking for yields to hit 10% before getting interested.
‘You want to invest but yields today are crappy,’ he says. ‘They should take the word “high” out of “high yield”.’
The long and short of it: Romick is top decile in the peer group over the last three years, while over 10 years he is in the top quartile
Lay down the law
Romick has managed the Crescent fund since 1990, first as a separately managed account, and since 1993 as a mutual fund. Co-manager Brian Selmo and Mark Landecker joined him on the fund in 2013, having joined the firm in 2008 and 2009 respectively.
He became a fund manager by accident. He had enrolled in law school but was offered a job by James Nathan, of hedge fund firm Kaplan, Nathan & Co, who he credits with teaching him how to invest.
‘He said to me: “I’m tired of unlearning MBAs, will you come and work for me and I’ll teach you from the ground up."
‘I just took law to stay in school as long as possible to delay my inevitable entry into the real world.
‘I went to work for him and gained an understanding of investing from a brilliant investor. It sat with me well.’
And it continues to do so. Value investing may be out of favor and central banks’ monetary easing may have distorted prices, but neither of these worry Romick, who is loath to look too far into the future.
‘I’m not going to lie and say I wouldn’t like to outperform every single year or every day. Psychologically, who wouldn’t? But practically it’s not attainable.
‘Our money is in alongside our clients'. We are in this for the long term.
‘We can only answer for ourselves and for what we believe. If the world is acting irrationally, we are hired to act rationally in the face of that. Sometimes that means owning what people don’t want to own and sometimes it means not owning what people want to own.’
Head of US Research, Citywire
The performance of the FPA Crescent fund is highly impressive. Romick has set himself a tough bar to beat in the S&P 500, as very few markets have kept pace with US equities. However, if you chart performance back to before the crisis, he is almost neck and neck with the equity market. What you get from this fund is lower volatility and drawdowns, with fairly comparable returns for a long-term investor.
Eyebrows may be raised at the large cash pile in the portfolio, with some investors understandably wanting a fully invested portfolio. But Romick is not alone in moving to historically high levels of cash, with some of the best mixed-asset managers in the world doing the same. The trap is that this liquidity is maintained for an extended period, with the management being reluctant to redeploy until the perfect buying opportunity, which might never materialize. However, I do not see that being the case here.