david nadel f royce fundsthomas russo gardner russo and gardnerCONSUELO 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

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