david nadel f royce fundsFull Transcript and Video: David Nadel and Tom Russo Interview on Consuelo MackCONSUELO MACK: This week on WealthTrack, finding the smoothest currents in a white water market. Two noted value investors, Semper Vic Partners’ Tom Russo and Royce Fund’s David Nadel (see my interview with David here- here)choose different routes to deliver less turbulent market beating returns, next on Consuelo Mack WealthTrack.

Video and full transcript below:

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. It has been a gut wrenching couple of weeks and, let’s face it, years for stock investors. The market volatility that so many WealthTrack guests predicted would become a fact of life is one. It’s not just the last couple of weeks, which saw the Dow for instance move in ranges of hundreds of points a day and experience what The Wall Street Journal described as “wild swings,” featuring session gains and losses of four and five and a half percent. The volatility has been building over the last decade. As you can see from this chart, the period from January 2000 to the present, encompassing first the tech bubble and then the much larger combination of a housing and credit bubble, has seen one of the worst market slumps of the past century. It rivals the roller coaster market declines which occurred during the Great Depression and the 1970s.
Since our launch in 2005, many of our guests have warned that the world’s economic and market dynamics have become so imbalanced and interconnected, between debtors and lenders, growing economies and slowing ones, aging populations and young ones, that we are bound to have financial earthquakes, tremors, aftershocks, and tsunamis. But that doesn’t mean any of these Great Investors have abandoned stocks. Far from it. But they have become even more selective in the prices they are willing to pay, the quality of the companies they own and they have become even more diversified globally.
This week’s WealthTrack guests are cut from the same cloth. They are both long term value investors who invest in stocks around the world, because that’s where the growth is. They have another trait in common. Over the years, they and their firms have been able to deliver market beating returns with less than market volatility. But they have done it in different stock universes- one in large cap global brand companies, the other in small company stocks. Tom Russo is a partner with the investment advisory firm Gardner Russo & Gardner, where he oversees assets of $4 billion dollars. His Semper Vic Partners Fund has outperformed the stock market since its inception nearly 20 years ago. David Nadel is director of international research at Royce & Associates, a long time leader of small and mid cap investing. He also manages or co-manages six Royce funds including the firm’s flagship international fund, Royce Global Value, which has far outdistanced markets since its launch nearly five years ago. I asked them both how they are mitigating the market’s volatility.

TOM RUSSO: Volatility actually is the friend of long term investors. It’s what creates the $.50 dollar bills. They say we’re supposed to buy $.50 dollar bills, but that doesn’t happen in a market which is rational, steady, and smooth. It’s during volatility periods like this that values open up and that’s actually good for the investor. It’s not very much fun for the money managers and the clients are often nervous, but it is actually first of all opportunistic.
Secondly, our companies are helping us through this period of volatility because it opens up for them a chance to buy back stock. So MasterCard’s bought back a billion and-a-half dollars worth of stock, at $200-something a share, over the last 18 months. That’s good. They are able to retire stock at a low price because of the volatility that we’re seeing. It also opens up opportunities for acquisitions. Berkshire’s made a couple of big acquisitions taking advantage of this volatility, Transatlantic is the most recent one. SAB Miller is buying Foster’s. Nestle is buying a Chinese confectionary company. Companies take advantage of the volatility–

CONSUELO MACK: So it’s not so much lessening the volatility; what you’re saying is that the type of companies you invest in actually take advantage of the volatility.

TOM RUSSO: Absolutely, yes. And then for my investors, I try personally at least with the investors I work with to have a relatively small amount of equity capital and I advise them before they talk to me to make sure they provide it for themselves in fixed incomes and other forms of investments, which today unfortunately are rather underwhelming because rates are so low in their savings account but they’re inclined to put more into the market than they should; but investors should keep dry reserves just for periods of volatility. Otherwise they will be shaking out at the wrong time.

CONSUELO MACK: So you represent and you know that you represent just a slice of their portfolios and the ones that they want to have in big global brand name companies. Okay. How are you mitigating the volatility during these kind of turbulent times?

DAVID NADEL: Well, Royce has for 40 years had a very disciplined approach to investing. And like Tom, I agree that volatility is the friend of a disciplined approach. It creates opportunities to add to positions that are high conviction. We have a very consistent strategy which I think also mitigates the volatility. We’re focused purely on high quality smaller companies. And they tend to be dividend paying businesses, which is quite a bit of a cushion in a downturn. In the terms of quality, we invest only in companies that have very strong balance sheets. Specifically half of their balance sheets needs to be funded by the shareholders’ equities. That’s a strong balance sheet. Businesses that generate consistently high returns on invested capital, we use a 15% hurdle. So these tend to be self funding businesses that take market share in tough times.
The dividend picture is also quite encouraging. I think people don’t always associate this with smaller companies, but 85% of the companies held in the Royce Global Value Fund are dividend payers. And dividends have actually, since 1930, dividends have accounted for about half of the return of the S&P 500. So dividends are a huge portion of the picture that I think a lot of people miss. We don’t really change strategy in this sort of a period. In fact, we’re talking before about, should we be at the office or shouldn’t we; it’s good to leave the office on a day like today when markets are down 5%. We stick to a strategy. We may add to some positions which are particularly high conviction. But we’re not changing anything; we’re really sticking to our guns, essentially.

CONSUELO MACK: Tom, to that point, it’s better to remove yourself from the noise, right, because otherwise you might do something that would not fit in with your disciplined approach?

TOM RUSSO: That’s very true. But I would say one thing. Going back to the 2008 model when there’s volatility- considerable amounts, more so than today- it did open up an opportunity to transform a portfolio. So long term buy and hold investors. But at some point when the market becomes overfraught with fear on something like the collapse of the emerging market- if you recall 2008, China and India dropped 70% toward year end. That was a great bell-ringing moment to take that volatility and for us at least, to sell a whole segment of domestic only companies that had decent values but no prospects for the kind of growth you get abroad. And those shares had come down so much that it was a very encouraging moment to swap.

CONSUELO MACK: So what about now? I mean, are there opportunities being created now by the kind of volatility we’re seeing.

TOM RUSSO: Absolutely.


TOM RUSSO: The story about the collapse, the beginning story about the collapse of emerging markets will be an opportunity especially from my perspective for those big global companies that are dominant in the developing merging markets. And we’ll be able to put more money to work. And more importantly, companies themselves will be able to buy more stock back.

CONSUELO MACK: So let me ask each of you, because each of you has a mandate to invest in the stock market. How concerned are you? I mean it sounds like if the markets go down, which they have been doing, that it represents opportunities. But there’s a point at which you are going to be paying for no matter what your portfolio is. So how concerned are you, David, for instance, when you look out at the global stock market’s global economies?

DAVID NADEL: Well you know, the picture, really, not that much has changed. In the last month or so other than a lot of stock market volatility, we still have pretty much the same story that was unfolding from the previous crises in the fall of 2008. This is a slow and continual decoupling of the creditor world from the debtor world. We used to have this framework of developed countries and emerging markets. I don’t think that’s really a relevant framework anymore. You’ve got certainly in the developed world in the U.S. and Europe, you’ve basically got stagflation; in Japan, you just have stagnation.
But the rest of the world, much of the rest of the world is growing quite nicely with the burgeoning middle class and all of the spending power. Sure growth rates may slow a little bit in some of the emerging markets or I should say creditor markets that are otherwise healthy, but it’s still pretty robust growth and it’s still a good demographic picture, there’s still fiscal responsibility in those countries. So I think we have tried to organize our portfolio around this notion that you know there’s the healthy world and there’s the less healthy world. And the advanced countries offer many great companies but we’re interested in the ones that sell to essentially the emerging markets in the creditor world, which is probably a similar strategy to Tom’s. So we would rather not be reliant on the consumer in Western Europe.

CONSUELO MACK: And so you’re buying companies, no matter where they’re based but that do business overseas in the developing world, whatever economies are growing.


And that is what you’re doing, Tom, as well.

TOM RUSSO: Sure. The trick there is that the valuation of the businesses that are burdened by the perception of slow growth Europe, because the vast bulk of my holdings are in European companies with global reach.

CONSUELO MACK: And that is because these are the global brands that are established.

TOM RUSSO: That’s right. They tend to have more shareholder mindedness in many cases; they tend to have bigger addressable markets in front of them that they’re able to pursue right now. If you think about Pernod Ricard pursuing the beer business, the spirits business in India and already having dominated it in China, they barely scratched the surface. So their brands are coveted and I think increasingly so as developing market consumers travel. And they visit Paris and they find people sipping Pernod Ricard or Martell or Chivas, they’ll come home with acquired tastes and the international market’s enormous. There’s half a billion cases of existing spirits in China. And the internationals sell six million. So you have basically four, maybe one and-a-half percent of the market with the ability to see that market grow in total volume and shift towards the premium side, which is what our companies will sell. The market burdens the valuation of Pernod Ricard because they have to be based in France. But the prospects are extraordinary because they can reinvest their money at high rates in markets that will grow for a long time.

CONSUELO MACK: Let me ask each of you and David, I’ll start with you- each of you has described it a little bit, but what are the characteristics of the ideal business that you want to invest in. What do you look for David, at Royce?

DAVID NADEL: Well I think essentially we’re looking for very high quality, which means a very strong balance sheet, sustainably high returns on invested capital, very good market position that’s defensible, a built of a moat. A Warren Buffett-esque moat —

CONSUELO MACK: But we’re talking about small cap companies, so do small cap companies have that kind of dominant position? I mean, are these very niche?

DAVID NADEL: Absolutely. So this is, I think, a misperception often in the investment community, is that small cap means small market share, or small cap means weak balance sheet and that’s why it has a small market cap. So we don’t invest in the weak balance sheet ones, but we invest in a lot of businesses that are actually global number ones or sometimes global number twos in their niche, so they actually have a good market share and with strong balance sheet and high returns, they are market share takers as things get tough.

CONSUELO MACK: So give us an example of a company that meets that description.

DAVID NADEL: Sure. So we have had at the top of the Royce Global Value portfolio for some time an Austrian company called Semperit. Semperit is a manufacturer of specialized rubber products. They make high end rubber products, things like industrial hoses, conveyor belts. They are actually the global number one in escalator handrails. Next time you’re riding an escalator you can think of Semperit, although it’s not branded of course. They’re the European number one in surgical gloves. This is a company which, you know, year after year produces a 20-25% return on invested capital. Very effective cost managers. They have grown earnings and revenue in 19 of the last 20 years without any significant acquisitions. And they pay half of their earnings out in a dividend. So it’s about a 4% yield, the stock trades at about, to Tom’s point about European companies being sort of tarred with this brush of being European, the stock trades are about five times operating income. And it’s covered by four analysts only. It’s just totally under the radar screen.

CONSUELO MACK: Right. There are a lot of those.

DAVID NADEL: But let me tell you one other stat about Semperit- it’s been listed on the Vienna stock exchange since 1890. It was founded in 1824 this. They know how to survive business cycles. That’s all they’ve ever done is specialized rubber products. So this is the type of business, when I say we invest in quality, this is the type of business that we want to stick with. You know, rubber prices may surge and people will run away from a Semperit because they don’t hedge their rubber costs. But they’ve got a great balance sheet, so they’re losing competitors every time rubber prices surge. This is the kind of business you want to stick with.

CONSUELO MACK: And this is what you’re talking about too. One of the things, Tom, that you told me in a previous conversation was that you also look for companies with the capacity to suffer.

TOM RUSSO: Oh yes. It’s a big deal.

CONSUELO MACK: So talk to us about that.

TOM RUSSO: I suspect in Semperit’s case, David, sorry, the prototype of a good company.


TOM RUSSO: I suspect you actually start with family control. I suspect it’s still family controlled because for me, the first question about a company is the culture- is it shareholder minded culture?

CONSUELO MACK: Why is family control, why does that make it a better shareholder culture, possibly?

TOM RUSSO: It doesn’t necessarily make it better. What it can do though is it can stretch out management’s time horizon. The biggest corrosive factor in business is the burden of trying to meet quarterly earnings. You have to have some resolve against that. It’s very hard to get. One way to get it is a stable shareholder base and that’s what we look for. A shareholder base that’s stable, that empowers our companies to invest into new businesses, into new geographies to extend their brands, even though doing so cost them short term earnings.

CONSUELO MACK: Sometimes it’s not just short term, sometimes it’s two or three years.

TOM RUSSO: Sometimes a good investment will take five years and ironically the last year will be the biggest year for the burden on the income statement. So think about starting up a new business. E.W. Scripps, a media company that we’ve invested for a long time created Home & Garden TV network and they committed at the start to invest $150 million from their income statement in the start up of that network. Well, by the last year, the fifth year, they were losing so much money they could hardly stand it but they didn’t risk losing the company because the Scripps family trust supported them. They had control and management knew they could see the story through to its conclusion. The conclusion is today a business that generates nearly $600 million worth of profits for the family through the public company. And we’re able to enjoy the benefit of that. So what I first look for is a corporate culture that’s shareholder minded. Against that you can’t win, especially if, like I, you have a ten-year horizon in investing, you’ve got to have that right, and then the capacity to reinvest is very undervalued. The businesses that we own have enormous addressable markets to which they can direct capital. But to do so, you have to have the capacity to suffer, capacity to reinvest–

CONSUELO MACK: Capacity to reinvest leads to David’s point about very strong balance sheets.

TOM RUSSO: Cash flow, balance sheet, brands, most importantly, in the world you global, you have to have a global management team with systems that allow them to stay the course, because otherwise you end up with chaos out in 180 countries. You have to have managements that are really adept in the international sphere and that’s sort of what Nestle or Unilever might stand out as avenues.

DAVID NADEL: In fact, I think that’s one of the great things about European companies in general is that they have never had the luxury of serving one unified 300 million person market that speaks the same language like the U.S. They have been forced to think pan-regionally or even globally for in some cases well over 100 years. So these are companies that are really well positioned for this new global economy. Ironically, a number of them are based in Europe and sort of get tarred with this feather but I, or with a brush, I should say, but they are getting a lot of their revenues from ex-European environments.

CONSUELO MACK: I’m going to change the subject just a little bit, or actually a lot and David, to you because gold is what, 12 to 15% of your holdings in the Royce Global Value Fund, or in gold mining stocks?

DAVID NADEL: Yeah, mining companies.

CONSUELO MACK: And you feel very strongly about gold, at this particular moment in history, why?

DAVID NADEL: Well, I think gold is, at this point, a severely under-owned asset which is, if you add up all of gold and all of the gold mining companies, gold comprises less than a percent of global financial assets. So you hear the talk of a bubble, this is very different from the tech bubble or the housing bubble where the guy on the street had a tech tip and people were flipping houses. People don’t own gold, so people are standing on the sidelines critiquing it as a bubble, but they’re not participating.

CONSUELO MACK: Despite the fact gold has gone up and it’s at record levels right now, even on an inflation-adjusted basis, you’re saying it’s only 1% of global financial assets, as opposed to 30%, you told me, in the 1980s? So gold is underowned?

DAVID NADEL: At various points of crisis, it’s been 20 or 30% of global financial assets. I think the notion that gold has gone up is missing the point. The real point is that the dollar has gone down. The dollar has lost 98% of its purchasing power in 80 years. It is not a reliable measure of value. We live in a society where things are measured in dollars and so people look at a chart of gold and they say it’s gone up, can it go up further? I mean, it’s really kind of missing the point. Gold on an inflation-adjusted basis is still 25% below its high. If you look at it on a Bretton Woods standard, which I think is even much more relevant, that is the ratio of the aggregate money supply to the U.S. government stocks of gold, the implied price for gold is $8,300 an ounce, because the money supply expanded so radically. And I think these numbers of gold at 2400 or 8300 may seem starry-eyed, but gold is marching up $100 a week at this point.

CONSUELO MACK: But you can’t own gold bullion, as you said, and so you’ve got to own gold mining stocks, which have underperformed the metals. So what’s your view of gold mining stocks? Especially small cap gold mining stocks?

DAVID NADEL: I actually think small cap gold mining stocks are in a better spot than the large cap mining stocks. The reason is that the entire production of gold each year adds only about one and-a-half percent to global gold inventories. So the large mining companies are not really able to move the needle, there are no big new discoveries. They are going to have to target the mid-tier producers in order to grow and in the case of the Royce Global Value portfolio, we have, for example, a holding in a company called Medusa Mining. Medusa Mining has its operations in the Philippines. They are producing gold with all in cash cost of less than $200 an ounce.

CONSUELO MACK: And they’re an Australian based producer.

DAVID NADEL: And they’re Australian based. With gold at 1800, it’s obviously very profitable. I think the way investors should think about gold mining companies today is the way large oil E&P companies were viewed in 2003. What happened then was the U.S. invaded Iraq, oil spiked from 20 to $30 a barrel. Suddenly E&P companies were highly profitable businesses and they moved from being asset plays to being earnings generating, dividend paying real companies. That’s where gold companies, the better run gold companies, are right now.

CONSUELO MACK: Now I don’t mean to- you’re not out of this conversation Tom Russo, because you feel as well that the dollar as a store of value is definitely under assault. So how are you replacing, what are you doing to basically replace the dollar? Where are you going for stores of value? Very quickly, but then I’ve got to get to the One Investment.

TOM RUSSO: So for us, we own global companies. Nestle and Richemont are both headquartered in Switzerland, which is for currency purposes, gold standard. But I even think that currencies of the emerging markets will grow their prosperity, and we own businesses 70% of the portfolios invested in companies that are really not in the U.S. and they’re focused towards building future streams of income that are coming through stronger currencies over times.
As far as the gold question, just a very brief observation- I look to Warren Buffett on this, because when things are more complicated than my pay grade, he usually has the right answer. And he cited that gold has sort of gone from where it’s been to the present price over a period time, and over that same period of time, Berkshire shares have gone from a thousand to 120,000, 108,000 today. And saw that the compound, because of the re-investment, outperforms over time. And so I just as soon personally own a business I can reinvest at high rates. It just gets repriced.

CONSUELO MACK: We’ve got to get to the One Investment. You mentioned Nestle, and Nestle’s your One Investment for a long term diversified portfolio that all of us should own some of, and just give me one sentence why.

TOM RUSSO: Capacity to reinvest. And the willingness to look out beyond just the short term performance. They’re taking their emerging markets of capital spending this year from a billion to 2.5 billion. It’s just an expression of the capacity to reinvest what they have.

CONSUELO MACK: David, what’s your One Investment?

DAVID NADEL: I’ll give you it quickly- it’s Spirax Sarco, it’s a British company that has revolutionized the steam management business; that steam is used in all kinds of applications, pharmaceuticals, foods, etcetera, etcetera. They increased their dividend for 42 straight years.

CONSUELO MACK: So guess what, we’re going to leave it right there. Thank you both very much for joining us, Tom Russo, we appreciate it, and David Nadel, thanks so much for being here.

DAVID NADEL: Thank you Consuelo.

CONSUELO MACK: This week on WealthTrack, we are reintroducing our popular Action Point feature, one piece of advice, an action you can take to build and protect your wealth over the long term. This week’s Action Point: don’t abandon stocks. Our guests this week are living proof that investing in the shares of top quality businesses, particularly ones with global reach, can really pay off over the long term. No matter how tempted you are to flee the turbulence, which we will continue to see in the overall stock markets, the only way to truly participate in the world’s growth, and it will grow, is to own at least some shares of financially strong, well managed companies, or mutual funds that invest in them.
I hope you can join us next week on WealthTrack. I will be talking to Yale’s visionary economist Robert Shiller. He predicted the tech and credit bubbles. What does he see in our future now? Until then, to watch this program again, just go to our website wealthtrack.com to see it as a podcast or streaming video. And while you’re there, check out WealthTrack Extra, where you can find complete extended interviews with other recent Great Investor and Financial Thought Leader guests. In addition, you can learn about our new WealthTrack app, so you can tune in on your smart phone or tablet, wherever and whenever you choose. Thank you so much for joining us and make the week ahead a profitable and productive one.