Francis Gannon: A Healthy Skepticism is Key to Risk Management by Royce Funds

At Royce, our more-than-40-year investment approach is built on the idea that preserving capital is just as critical to successful long-term growth as growing it. Portfolio Manager Jim Stoeffel talks to Co-Chief Investment Officer Francis Gannon about his auditing background and how that experience influences the way he assesses risk.

See the video here.

Francis Gannon: A Healthy Skepticism is Key to Risk Management

Francis Gannon: Jim, how do you describe yourself as an investor?

Jim Stoeffel: I’d say probably the key aspect of investing for me is really risk management, and it really stems from my background. My formative years were spent as an auditor and a CPA including, interesting enough, a period of time doing fraud audits.

I’m a bean counter, I’m a numbers wonk, and I really like to get as deep as I can. But there is another aspect of auditing that’s known as a healthier skepticism, and I think you really need to bring that to bear when you’re talking to companies, when you’re looking at the financial statements, and to me it goes to what we do at Royce—to have that skepticism, to make the management teams prove what they say they can do. Because every management team comes in with a story, sounds good, everything’s great. You know, I think you really have to approach it with a healthy ear of skepticism, which I think is good.

Francis Gannon: So let’s talk about risk. It’s a big, broad topic; very topical in today’s environment. What are the things you do to mitigate risk when you’re looking at a company?

Jim: Well, the key one, obviously, is the balance sheet. But really I’m looking for companies that have high returns on invested capital, and it’s sort of twofold.

In my opinion, it’s sort of the number that encapsulates everything about the business: the economic moats, the competitive moats. And the high return on investment allows you to, obviously, potentially get more from the equity. The only way you can really get true equity returns is, obviously, if you’re investing at a rate higher than the cost of capital.

So really, looking for the return on invested capital and really going through the financial statements are key ways for me to attempt to mitigate some of the risk.