In a podcast interview, Senior Investment Strategist Steve Lipper asks PM Bill Hench about the distinct approach to value investing that he utilizes in Royce's Deep Value Strategy, the most important lesson he learned from Buzz Zaino, and more.
Listen to podcast here.
Steve Lipper: Hi, this is Steve Lipper, Senior Investment Strategist here at Royce Investment Partners. And thank you for joining us today for Three Questions With. Today, we have Bill Hench, portfolio manager and principal at Royce Investment Partners.
Bill manages a variety of different portfolios in the same strategy for clients around the world. He and his team manage a U.S.-registered mutual fund for U.S. investors, an off-shore fund for non-U.S. investors, a collective trust for qualified plans, as well as a commingled vehicle for institutional investors. Bill joined Royce in 2002 after spending 10 years in the institutional equity business. He began his career getting a CPA, and he has over 28 years of investment-industry experience. Bill, thank you for joining us today.
Bill Hench: Thank you, Steve.
SL: So Bill, you and your team have significantly outperformed the small-cap value index in both long- and short-term periods. How have you and your team been able to navigate this challenging environment so well?
BH: Sure. It's been challenging and crazy, as well, I think. We always deal with uncertainty, and you never know what's going to happen tomorrow, right? Part of what we do is figuring out how we think things are going to end up. But there's usually a little clarity somewhere, and now we're dealing at a time where there's not much clarity at all. For the most part, nobody has any guidance. So everybody's in the same boat. Most of the companies that we own and actually almost all of the bigger companies have told you we're not going to give you any guidance because we can't see.
For us, that's not a big deal. And it's actually probably a little bit of an advantage maybe versus peers who are not used to that. You asked how we've done this, and we've really ignored sort of, you know, the present-day things that are leading to numbers that are really ugly and tried to normalize things. And as we say, we don't want to be a part of the church of what's happening now, right? We want to know how things are going to be going forward.
And these are difficult times. And typically, with us, when things are rotten, that's when we make our money. That's when you're able to get inventory for the portfolio at really, really good prices. And it feels awful. I always chuckle when I see people on television saying, "They can't wait for the market to pull back 10%, because then I'll be able to buy." And that's nonsense. Nobody wants to lose 10%, right? You want to buy a stock today, and you want it to go up tomorrow, because we're human, right?
But that doesn't happen. And with us, you really tend to get a lot of opportunities to make a lot of money. And if you look in the newspaper or if you look on the screen, you'll say, "He's not making money." But we really are, because we're really buying things at such a tremendous discount to what they're really worth. And again, you're not going to see that today or tomorrow or next month or maybe even next quarter. But down the road, the true value, if we did our job right, we'll come out, and we'll be able to get the returns. And that's really what happened, right?
So in March and April, we were given the opportunity to buy these things, and it was unpleasant. It wasn't a pleasant experience in the Financial Crisis or the tech crisis. But you do have some confidence, and the more you live through these things, the more you experience these events, the better you feel about the eventual outcome, which doesn't guarantee anything, but it does give you more confidence to execute on that. And that's what the team did.
So Suzanne and Rob and Adam and myself all went out every day and tried to figure out, "What are the things that are now in really, really dire straits according to their prices? What are those things going to look like when things get better, if things get better, right? And if so, what's that spread?" because when you're down that much in an ugly period, you can't get defensive, right?
There's no reason to be in the game. So you have to make your bets. You have to think logically about what's going to give you the most performance coming out, not what's going to not do badly, or this will be okay. It's already too late for that, right? You're in the game, and now you've got to think about how you're going to make money for your clients going forward, and that's what we did.
SL: Yeah, I'd love to talk to you a little bit more about your distinctive approach to value investing. It's one that differs from many other managers, and specifically, you have a more broadminded approach that has allowed you to be active in both tech and healthcare over the years. Can you take us through how it is that you execute a true value approach in areas that other value investors tend to be light in?
BH: Our approach is very straight, right down the middle, right? So it's low valuation. And it's based on, not necessarily current earnings, and point of fact that's almost never based on the current earnings, but rather what normalized numbers would look like. And the starting point is always the same with us. We look to traditional things like price to book and price to sales.
And that sales number is key, because that's where you're going to get your leverage. And what you find, not surprisingly, is that tech and healthcare really act no differently than any other industry that goes through waves of euphoria and then, very, very fallow times when it comes to earnings, as well. So all we do is take advantage of the cycle. Not just the economic cycle, but as somebody else pointed out recently, product cycles, too, right?
And the nice thing about tech and healthcare is that a great deal of those names tend to be heavy in cash. So it's not the typical value name that you have to be very, very careful of because of the debt situation. A good deal of these names are net cash. That's a dream for probably any investor.
SL: When elective surgeries were postponed, or they said that they couldn't go on, there was a whole bunch of a variety of different healthcare companies that really declined as though elective surgeries were never going to resume. And I know that that's an area that you guys took advantage of.
BH: Right. And as is typical for us, we really didn't find it a dramatic amount of opportunities in pharmaceuticals or drugs or biotech. But rather in facilities, whether it be hospitals or surgical centers, devices, anything that was really affected because there was a virtual shutdown. Not really different than airlines and restaurants for non-essential procedures.
And again, the nice thing about names like that, similar to some of the consumer names, is that they really give you a sort of bonus for a value player. And that you really get a growth stock at a value price or something that would be considered more of a core stock, yet still has those metrics because of the current circumstances.
SL: Yeah, that's great. So let's turn to the current market, and perhaps share some of the areas that you and your team are really attracted to now.
BH: Sure. So we don't keep our weightings in line with an index of any sort. We have a stock-by-stock approach. Admittedly, that over the years, there's been some consistency to some of those overweights and underweights. So we tend to have a lot of tech, as you mentioned before. But right now, what are we doing? We're taking advantage of circumstances that aren't pleasant for everybody. But for those who aren't subject to the same restrictions that others are, they're really getting the lion's share of business. So what are we saying? That things like autos and home building are really doing well in this environment. So we've got exposure there. And things like energy and aerospace and retail and small banks are not doing well. And some of that was happening before the crisis, and some of these things have become worse than that.
And others had no issues, and then became victims there. So the portfolio is weighted to where the action is, right? To where we think that these names that we get, that could use a little help getting back to normal are going to really benefit. And what's happened with our portfolio is that things have gotten a little better a little quicker than we normally see in a portfolio like ours. The things that we've bought since March, the reason that they were cheap wasn't necessarily because there was an issue with production or with competition or some other event, but rather something that affected pretty much the whole market.
And therefore, there was a depression in prices and multiples that had nothing to do with the fundamentals of the business. That's been a little different for us. But we're, I think, having some relative success, based not on just what we have, but what we haven't had, as well. So the things that we didn't buy, or those things that stick out as, "My goodness, you have to look at these. These are really value stocks," really aren't value stocks.
SL: I've heard you mention before about positioning a number of holdings that are positioned for an eventual return to normalcy. Can you tell us more about that?
BH: If you don't think things are going to get back to normal, then this fund, or any other fund, isn't going to help you, right? I don't want to be cavalier about it, but we don't know when it's going to happen, but as in other calamities or disasters, there will be an end to it. People will work to get back to where they were or back better than where they were. That is reflected in our position, so it's why we own some airlines. It's why we own some restaurants. It's why we own anything that really didn't have an issue, say, for the fact that everything just stopped, right?
So hopefully, that positioning or looking ahead, which is what we normally do anyway, will come back and pay dividends for us. Again, if you're of the opinion that this is going to be something that's going to take, you know, an incredibly long time to get back to normal, or you don't think we're getting back to normal, none of these things are going to help you with your economic goals of making money.
SL: You also shared an insight recently about a shortage of inventory in a variety of industries. It doesn't seem to be talked about as much. And some of the opportunities around transportation or around that ecosystem of the rebuilding of inventory. Can you share with us your view there?
BH: A lot of the inventory news is coming out now as quarterly earnings are being reported. An RV maker talked about not being able to get as much product out because they couldn't get parts. One of the team went to get a dishwasher for their home, and there is no inventory at the retailers down in Texas. I thought about trading in a car for another one, and there were none on the lot. There are pockets of just zero, and so there will be some sort of restocking trade.
It seems to have hit most of the industries that we've been looking at. They'll get a good snap back. I think there's probably a little bit of a trade in here for it, but it is interesting to see just how quickly things can get to a point where all of a sudden you go from an abundance or, you're reading one month about the auto lots have a three-month supply, and now they've got, for the stuff you want really, nothing. There's always a measure of product out there that nobody will want at any price.
SL: Right. There's plenty of product that nobody wants that's available. I really appreciate those insights and where you're positioning the portfolio to benefit. Let's pivot a bit away from the portfolio, ask you just a couple of questions. You had mentioned Buzz Zaino earlier, and you worked with him for a good long time. What would you say are some of the most important things that you learned from Buzz?
BH: Let's see, it's a long list. Most important was how to sell. I think a lot of people over the years have talked about how difficult it is to sell. And especially with us, because so many of the things we buy are truly projects and take a while to work out. And in many cases, what we're buying is actually getting worse as we're buying it in the beginning. You have to trust your instincts, and then also what you've learned not only from the company, but from your past experience, as well.
So having patience to go through that and then seeing it and making the money in the position that everybody was laughing at you because you owned it, you're reluctant to give that up, right? Because you've got a certain amount of pride, and it makes you feel good to see something at $20 that you bought at $4 makes you feel smart. So getting rid of those things is very, very difficult.
And, you know, part of the process that Buzz developed was not letting things get too big, and having a process where you, sort of, automatically cull it back every day, regardless of how wonderful it seems, right? So it's a long way of saying he taught me not to fall in love with your names. That's probably one of the most important things. I could go on for a while with other things we learned. And we could talk about cannolis and other wonderful things. But we could probably save that for another time.
SL: Yeah, that's great. Bill, I know you are really a voracious reader. You're always reading at least one, if not two books. Can you tell us what are you currently reading, or what have you read recently you might recommend?
BH: I just finished, a book that one of our associates at Royce loves, I think. And it's called, The Mansion on the Hill, and it's about the music business. I guess the rock and roll business from its infancy, and how it grew, and the different turns and how it went from, I guess an art to a business. And one of those books with terrific real-life characters. It was a nice quick read as well, and it's somewhat current, because most of the people are still with us. And those that aren't, you could catch on the radio still.
SL: So let's continue with the music theme. A number of us know that you're quite a passionate music fan and have an extraordinary level of knowledge, as well. What does being such a passionate music fan do for you?
BH: Oh, it, keeps me away from looking at screens all day. It's like anything else you love. I love to invest. I love to do what we do. It's very similar to what we do in investing, in that there's lots of different things to look at, right, and different styles and different ways that people use their instruments and their voice. The thing I like most about it is the originality, and how someone could come up with something that just seems so out of left field.
And then just become so wonderful, you know, an unexpected sort of treasure from somebody who you never thought of. It's, "Oh, I never thought she or he would do that." It's never ending, and you could listen to the same songs over and over again and still get something different out of it.
SL: That's terrific. Well, Bill, thanks for walking us through the portfolio, the areas you're positioned in, and your outlook, as well sharing us with some of the other perspectives outside of the portfolio. Really appreciate you taking time to join us today, Bill.
BH: Thanks so much, Steve.
SL: And thanks, everybody, for listening.
This transcript has been edited for clarity.
Mr. Lipper's and Mr. Hench's thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. The thoughts and opinions expressed in the recording are solely those of the persons speaking as of October 21, 2020 and may differ from those of other Royce investment professionals or the firm as a whole.
The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.
