The transcript from this week’s, MiB: Steven Romick, FPA, is below.
You can stream and download our full conversation, including the podcast extras on iTunes, Spotify, Stitcher, Google, Bloomberg, and Acast. All of our earlier podcasts on your favorite pod hosts can be found here.
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BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have a special and fascinating guest. His name is Steve Romick, he is the managing partner at First Pacific Advisors, a shop in LA that runs about $26 billion in assets. He has also run the Crescent Fund since 1993, it’s about $11 billion and the numbers on that fund are really quite astonishing.
One of the reasons I first wanted to start doing podcasts and interviews of asset managers was because of people like Steve Romick. You know, he’s not on the cover of magazines, you don’t seem on television all the time but here’s a guy running real money, a substantial amount of assets with a fantastic long-term track record and he is not a household name. I think the average — forget the average investor, the average professional probably doesn’t know who Steve Romick is and that’s too bad because folks like this really allow you to learn an important lesson about how to manage risk, how to take advantage of opportunities, what you should be thinking about as a portfolio manager, as an investor, really just a fascinating guy with a really interesting history.
I found our conversation to be really intriguing and I think you will also.
So with no further ado, First Pacific Advisors’ Steve Romick.
VOICEOVER: This is Masters in Business with Barry Ritholtz on Bloomberg radio.
RITHOLTZ: My special guest this week is Steve Romick, he is the managing partner of First Pacific Advisors, a shop that runs over $26 billion in equity fixed income and alternative strategies. He was the MorningStar US allocation fund manager of the year. He also manages the $11 billion FPA Crescent Fund which he’s been running since its inception in 1993. Steve Romick, welcome to Bloomberg.
STEVEN ROMICK, MANAGING PARTNER, FIRST PACIFIC ADVISORS: Thank you, Barry.
RITHOLTZ: So let’s go back to the early days of your career, you began as an analyst in 1985. Tell us what industry you were covering.
ROMICK: I started out as a generalist. I actually started out as a generalist who knew nothing about everything. I was on my way to law school and I met a gentleman, through my father who decided that that he wanted to bring somebody into his shop who didn’t know anything because as he quoted it, at the time he was tired of unlearning MBAs and he put me up in his office, pushed a desk right up next to his and said you’re going to see what we know how this works and what we do, and he did – everytime you called the c, he had me on the phone with him and I learned early on that the industry that I focused on to the greatest degree in my earliest years in the mid-80s, you know where it was the bank and thrift industry when there were almost triple the number of banks and thrifts in the United States, there is a massive consolidation trend that he identified that was likely to occur which of course did occur.
And he had me to spend a lot of time analyzing these companies and inputting hundreds of banks and thrifts into DBASE, something we don’t really use today anymore and I spent a lot of time analyzing these businesses, and then I just took it from there and continued, you know, that breadth and spent a lot of time looking at different parts of the capital structure as well, and to stressed that and stressed that in addition.
RITHOLTZ: So you mentioned DBASE, how different were the tools that you used in the 1980s and the techniques that were mainstays in financial analysis then versus today, how radically has the world of analytical research changed.
ROMICK: Well, I think that the — I don’t know if the process is any different but the tools you can use to get the information that one needs to make a robust decision are better, I mean it’s just easier to gather information which makes the world you know, candidly more competitive today than it was back then.
Not only is there more money sloshing around the system, not only are there more people doing it, but they can get that information a lot more easily. I mean back then, I had to get on the phone and call a company and call them for local information to get to the phone number of the bank’s headquarters and or whatever company headquarters it was and try and get in contact with investor relations if there even was an investor relations department, more often than not, it was just trying to get a hold of somebody in the finance department to get them to send me an annual report.
And to seek information, you know, on the competition, to seek information as it relates to industry data. You know, it was just all much, much harder to come by. It required a lot more work just to give mission now that information is available at your fingertips on the web. And in addition, you have so many great resources that exist today for people looking at businesses, the world’s become much smaller.
You have podcasts like this, you’ve got value investors club, VIC, et cetera.
RITHOLTZ: Interesting. So you were working as an analyst covering everything generally. How did you decide to become portfolio manager and what was that transition like?
ROMICK: I think — that’s a great question, because I think that everybody who is reasonably good at this and is confident of their capabilities, at some point they want to reach out and touch the money themselves other than somebody else make that investment decision. So it started out with my personal account inside of the firm in investing and finding some you know failure early to realize you know my — what not to do and then as I got better over time, I thought that that this might be something that I want to do in terms of managing the entire portfolio as it began to really develop a philosophy as to how I like to manage money.
And I was very fortunate to have a mentor who helped, you know, push me in that direction and became one of my early investors.
RITHOLTZ: Really intriguing.
So you founded Crescent Management in 1990, how did you launch this business? How did you get it off the ground? Where did you find clients and what did the business look like in those early years?
ROMICK: 1990 when we started this, it was – I had a partner at the time who both of us had worked for our mentor, his name is James Nathan, he goes by Jeff Nathan, and he – you know, it was basically arranged marriage where he decided that we’d be better off you know, building our own business that there was an opportunity for us.
He allowed us to do that while we remained as consultative analyst for want of a better description with his firm, so he could have his cake and eat it too if you will. So it was mutually beneficial.
And the early clients really came from his relationship. He put us in business and I owe that, you know, all to him. We didn’t really have, we didn’t have a – at that point in time and we that we launched with maybe I would have to go back and think about how many millions it was but maybe it was $10 million total between separate accounts and the mutual fund and it gradually grew from there.
RITHOLTZ: When you launched, was it all equity, was it equity fixed income, or was it unconstrained and you know, including alternatives and nonpublicly traded options?
ROMICK: It was it was unconstrained within the public security markets, so it did not include anything that was in the private sector, whether it be private credit or the odd private equity investment that we might make today.
And today we continue to be largely public security investors, but philosophically at that point in time, I like the idea that I was able to invest money in a way that could deliver high risk-adjusted returns or believe that could deliver high risk adjusted returns to my client base by investing across the capital structure.
We had come out of the – you know, was coming out of the recession at that point in time and then the Drexel burn and blow up and there were lots of opportunity in junk-bond land then I learned that I could get a rate of return in the debt markets that was as good as the equity markets with more downside protection and I could use as a tool in my portfolio and if I could do that, I felt that my clients would benefit because the portfolio could deliver higher risk-adjusted returns and volatility as a measure of risk as I think of – it’s silly because it’s just things move around a lot and the temperature outside today in Los Angeles does not — doesn’t reflect what the temperature might be tomorrow, it’s just going to – it’s going to move around.
So when it comes to investing though in the average person, this goes for many professional investors, I think that volatility does weigh on on them and it does precipitate action. Stocks go up a lot, they need to get in, the stocks go down a lot, people will panic out and this is about making a universal statement, but it’s all too often true.
And I found in dealing with individual clients and very it was very much true and I felt that managing a product that could mute that which was not the goal, it was just a byproduct of my process was something that that could be a reasonable business.
RITHOLTZ: And clearly it became a reasonable business. When did Crescent become part of FPA and what was that transition like?
ROMICK: That was in 1996, and the transition was actually a very difficult transition for tragic reasons. I — my partner and I split up, he took separate accounts, I took the mutual fund and we – I brought the assets over to First Pacific Advisors. I realized that I didn’t want to deal with the back office and I didn’t want to deal with the marketing and I just wanted to focus on investing.
And all the nuts and bolts of the business side of things, I wanted to leave to an organization that could have my back, if you will and provide that piece of mind that I can just you know, focus.
And so I joined First Pacific Advisor and I was friends with either of these this investment group that I was part of at the time through my again my mentor that were guys who were older guys, I mean younger than I am now who would sit down and talk about businesses, investments, every couple months and they get together for dinner and you’d had to bring your best idea and you would chat about it and they let me come and be a fly on the wall, because I clearly had nothing that at that point in time.
And one of those gentlemen was Bob Rodriguez who was portfolio manager at First Pacific Advisor at the time we became friendly and I thought out and sought him out and others regularly to bounce ideas off of and compare notes in different businesses. And Bob knew I was looking to find a home and he was kind enough to allow me into their discussions with First Pacific Advisor which is run by George Michaelis at the time who was a well-known investor, featured in JohnTrain’s book, “The Money Masters” volume 1.
And I spent a lot of time with h George, who I new peripherally through mutual friends and it just seemed like a very, very good fit. And I came into FPA in ’96, in mid ‘96 and early ‘96 and 10 days after I joined, George Michaelis was scheduled to have dinner in my home that night and went cycling first and then had a bike accident and died.
RITHOLTZ: That is tragic and really just robbed you of the ability to work with him for all those future years.
So it really kind of shows just how random life can be and it ties into the question I was about to ask you which is, you’ve had one of the longest 10 years in the mutual fund business, you have been running the FPA Crescent fund since its 1993 inception, what is the secret to this longevity?
ROMICK: Well, I think you have to enjoy what you do first and foremost that I do. I mean if people ask me when I’m going to retire and I have no plans to do that because I enjoy coming to the office every day. I enjoy reading about businesses, I enjoy learning, and this is a you’re in a constant state of learning, the world is so different today than it was then and company and industries have evolved and it forces you to continue to study.
And you never perfect this, it’s a constant process of self-improvement and as I look around me, I think that’s what keeps me young and so I’ve really have no intention of stopping this anytime soon.
So that’s the – I think the first, you know, key to that longevity and I think second is just that we happen to create a product that for better or worse is different than the typical product. I mean sometimes we will look like the typical mutual fund, we will look very ordinary for, you know, sometimes longer periods of time because there isn’t a lot of opportunity you can say in the debt markets, there hasn’t been over the last number of years because we have not been interested in buying high-yield bond without the — without the high part of the yield because there has been much yield.
So we end up just more in equities than we have have historically. And so but we do have that opportunity, that flexibility to operate with great breath whether or not we take advantage of it at all points in time or not, it’s that opportunity does exist. I think that can make us a little bit different than the typical one and it doesn’t make us the right investment for everyone but we’ve kind of committed to get myself and my partners in the fund now because one thing that has also allowed me this longevity is to have terrific partners in Brian Selmo and Mark Landecker who are wonderful partners and wonderful analysts, and wonderful portfolio managers and thoughtful and kind people with lots of integrity who make it fun to come in each day.
And so having that kind of support around you along with our analyst team and support of of the of the organization First Pacific Advisors makes it, you know, makes it enjoyable.
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RITHOLTZ: Let’s talk a little bit about what it was like managing all those assets in the midst of the worst pandemic in a century.
Heading into the end of 2019, you were running more than a third cash in the fund, what was the thinking then?
ROMICK: Well, we have always managed a fair amount of cash in the portfolio …
RITHOLTZ: But that seems pretty high, 36% is a lot.
ROMICK: It is, and it was certainly above average and it wasn’t that we identified the a recession is about to come as a result of a pandemic and the world would literally stop and many industries.
But it was really, you know, more a function of cash being a byproduct of our investment process. If we find an investment we like, we buy it, if not, A, cash ends up as a residual. So we were more comfortable owning more cash in the past than we are today because at a point in time, cash yielded 5 percent back in the early 2000’s in the mid 00s and we have more concern today B, that that inflation might be prospectively higher given the amount of debt that’s been issued, by the paper money that has been printed and cast would be worth a lot less in the inflation environment.
So we came into this recession and into the pandemic in early 2000. We had that cash again just as a byproduct of that and we thought we were actually more protected with the cash reward but the investor part of the portfolio you know, was scantily hit pretty hard by the by the pandemic.
RITHOLTZ: You are down 34 percent will do that, right?
ROMICK: Yes, but it was this is some of the business we owned were people throughout for dead for a period of time, we own companies like AIG that started the year at around 50 and at the end of 2019 going into 20, it peaked at mid-50s and an intraday in the and the third fourth week of March 2020 it was trading down at under $17 a share with book value being up you know, closer to where the price was at the beginning of the year.
So huge, huge discounts and people believe that they the company was clearly on its way out, you know, of existence. And we didn’t believe that and we took the opportunity to increase our position but it was still, I mean it admittedly was discomforting at that point in time not only for us because who likes to see their stocks drop that much.
But certainly for our investor base, but at the end of the day we understood that many of these businesses we own, it was just a blip, it was just a price at a point in time with fear you know hitting the market and it wasn’t the that these businesses weren’t going to do well once we got through to the other side, and business like AIG you know, are going to be fine and it’s businesses like Marriott, it’s businesses truly stopped and we were buying in a Marriott as the stock was coming down and you buy a stock at 80 and then it goes you know it goes into the 60s you know it it’s not again, the most comfortable thing to watch happen but we are very confident that as we got through the pandemic, people once again would travel, they would get on airplanes, they would go to hotels and a company like Marriott that is more asset light that some of the hotel businesses would perform you know quite well.
So you know, buying something it at 60 and I’m sorry, at 80 you know as it is a drop-down is a drop-down another to 20 percent to 25 percent from there, you know, again as I said was discomforting but at the same time, you look where it is today where its 140 plus, we clearly weren’t wrong but it took a market that point time is it took a lot of those businesses down with it.
So we took advantage of the opportunities at that point in time and increased our invested exposure by about 10 percentage points and pulled down some of that cash you are referencing.
RITHOLTZ: So I don’t want listeners to think this is hindsight bias or you know after the fact reinventing history, March 20, 2020 there was an article in the “New York Times” by Jeff Sommer, and remember this is deep into the collapse about a week before the market bottoms and he described getting a note from you saying you had begun to start buying stocks and felt that if even if markets fell further, you were going to continue to buy as you thought things had suddenly become very attractive price wise.
And that you said you are acting rationally and not bravely and you’re looking at 5 to 7 years. Tell us a little bit about the reaction so that “Times” column about you buying right into the teeth of the collapse.
ROMICK: Reaction from whom, Barry?
RITHOLTZ: From whoever, from investors, from you know any – I found anytime I see someone go against the dominant trends, stake out a contrarian point, the general pushback is ranges from this guy’s an idiot to this guy’s crazy. Were you getting sort of hey what are you doing from clients or…
ROMICK: We got the specter, we got both…
RITHOLTZ: Right. I mean, but you have been doing this long enough and your track record is good enough that one would hope long-standing clients would say I don’t know but I want to give you the benefit of the doubt because you have been right before. What was the pushback like?
ROMICK: The pushback from some people was your portfolio took a mark, we didn’t expect it to take a mark like it has and so we are going to go and the give our money to somebody else, that was the pushback from some. On the other hand, we had those investors who increase their capital commitment to us and decided that what we’re doing was the right thing because it did buy into the argument you just made that hey, these guys have been doing this a long time. They have lived through various cycles. They lived through the Internet bubble. They lived through the junk bond blowups in the early 2000’s when the WorldComs were there and were able to take advantage. They lived through the great financial crisis and they – these guys know what they’re doing. I would rather them do it than somebody else.
And so we did have, you know, fortunately those people as well. On the other hand, there were more the former admittedly than the latter, you know, people tend to vote with their feet and this goes back to that volatility argument that people get a little panicked at these points in times, and we just try to be thoughtful and act rationally.
And at the end of the day, if we do the right thing, the business will take care of itself whether it will be, you know, whether we are smaller or we are larger, it’s not going to change what we do every day when we come in here. It’s not going to change our lives.
So it’s very important for us to always be mindful of what the world will look like in five to seven years down the road, and make sure that we have analyzed the businesses that we own or the assets we’re buying, the bonds that we’re buying well such that we have invested with some kind of margin of safety and we try to anticipate, you know, downside.
And downside not just in mark to markets that might occur which are far less important but really considering what the absolute downside is, what is that — and what could really happen that could create an permanent impairment of capital.
RITHOLTZ: So before we get granular and really dive into what you were buying, I want to ask you what made you realize that the selloff in 2020 was a short-term selloff and not the start of a more serious longer-term bear market? Was at valuation? Was it a variety of factors? You obviously had the right answer, what was the thinking behind it?
ROMICK: Oh I didn’t know, I mean just full disclosure, we had no idea it was going to be short or long.
RITHOLTZ: (LAUGHTER)
ROMICK: I mean, we, I came that article you referenced in the “New York Times” was as you stated, we’re thinking about where the world is going to be down the road five to seven years, I didn’t know how long this was going to last.
RITHOLTZ: Right.
ROMICK: But if I invest trying to anticipate what is going to happen in the next few months, six months, a year whatever the case may be, it’s just it’s – going to take my eye off the ball – our team’s eye off the ball and not allow us to buy things we otherwise might buy.
We would always find some reason that that it might be a little bit cheaper.
RITHOLTZ: Right.
So let me get specific then, since you were thinking five to seven years, what did you accumulate at the end of that first quarter and the beginning of the second quarter, what specific sectors or stocks?
ROMICK: You know, we bought a number of businesses in the travel industry and including Bookings.com and Marriott, we bought businesses that were impacted you know, directly by, you know, by COVID, we added to some of our financial services businesses, you know, AIG I give as an example that we felt that would certainly get through to the other side, and we added businesses that last year that were — people were capitulating because the consumer is going to be weak, businesses like Richemont for example.
And then we also took advantage of other businesses that there were less cyclical that that have the opportunity to perform well regardless of what you know what the economy you know was doing, but were just – were being negatively impacted by the market, and they were throwing the baby out with the bathwater as well.
So we owned in the portfolio and then their positions that grew within the portfolio while we were when the market is going down in companies like Facebook and Alphabet et cetera.
RITHOLTZ: And I know you like to run with a little bit of cash in the portfolio, did you ever fully deploy that capital? Did you become fully invested?
ROMICK: No, we didn’t, we booked the capital, we took 10 points of the capital and put that to work and then the market rallied, you know, from there.
And we didn’t put it all to work, you know, in hindsight, obviously, you know, one wishes they had but we didn’t know how long that opportunity existed and wanted to make sure we could have the ability to buy down.
RITHOLTZ: No doubt about it. What else were you doing to manage the portfolio through the course of the pandemic, meaning how are you approaching dealing with clients, dealing with buying opportunities, considering risk, how did you do the pandemic affect the way you thought about running the funds?
ROMICK: We had lots of conversations about this and certainly, amongst my partners and probably the most grounded of the three of us I would give the hat tip to my partner Mark Landecker who really was the most centered of us. Because I’m not going to tell you that it wasn’t disconcerting watching the stock prices drop, you know, as it did, even after having lived through multiple downturns.
And we — they left more of the speaking to clients to me which you know I have a history with them and allow them to a greater degree, focus more on the portfolio and not have the static from having clients whisper in your ear you know your portfolio is going down, I’m scared, you know, what are we going to do, what are you going to do, what am I going to do? It insulates them from hearing the different reactions of the investors and so I took more of that on the front line.
And because you have to be a good investor, you really do have to have us discuss that longer-term focus in and find ways to minimize the static in your life. And so that’s how we operated, you know, together, the three of us.
RITHOLTZ: Really intriguing. So given the big run-up from before the drop from February were up about 17 percent from the nader, we were up about 75 percent, are you still as fully invested as you were last year, how are you looking at the markets today after this recovery?
ROMICK: There’s no question that things have gotten pricier but every time you put capital to work out fast yourself or even maintain your exposure, what’s — what could happen over the next five to seven years, these businesses, these assets that we own, and our thought process is continues to always be focused on looking out down the road.
And if one starts with that, we then have to and with what is the alternative to this or we end up concluding, what if you — bonds don’t offer much of an alternative and you are not getting any kind of yield there, we kind of think of that as more as return free risk, the high yield part of the market or the investment-grade part of the corporate debt market just isn’t attractive. And we wish it was, we took a little of capital to work, you know, in this space last year but the opportunities exist you know for very long and so much of that corporate debt is not only lower yielding but it’s also relatively, covenants to a lot of that tax – debt.
So more of the leverage tilts towards the to the borrower and away from the lender.
And so we don’t we look today that same situation physical yields are lower still and it begs the question and the answer for your question, why would you be as investor, we were slightly less invested in fairness but that’s more noise in the portfolio than we were in the last year this time, but why do we stay invested because again the alternative isn’t great and we think that we were going to get good rates of return over the next number of years from this portfolio of assets that we own.
That doesn’t mean that they’re not going to – stocks aren’t going to trade down in the interim, they very well might, but when we look at the way the government has printed money government some sovereigns have printed money and you know and then as I pointed out earlier, just the amount of debt that’s been created we just think that you know you could be you could tilt towards an environment where it’s more inflationary and rates could remain lower for longer because the government imperative is to keep them as low as — interest expense as low as it can be which means keeping rates as low as possible.
At any point in time, the system can — the government lose control of that but we considered what the alternatives are, stock still make more sense.
Now we are finding more opportunities outside the United States and we think that there’s better opportunity in businesses that are domiciled in foreign shores and so our portfolio of equities has tilted in the last couple years more overseas than it has been or is ever been historically, the position size has about doubled for a few years back for that which we have owned outside the US and now 40 plus percent of our portfolio is domiciled elsewhere.
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Let’s talk a little bit about that Crescent Fund, it has been ranked as the best risk-adjusted returns of all allocation mutual funds with at least $1 billion in assets under management among those managed by the same manager since inception, which I would imagine is a fairly exclusive club. Are you familiar at all with who else is similarly situated to you in terms of running a fund since inception and actually running a billion or more dollars?
ROMICK: I’m not actually, I don’t really pay a lot of attention to that.
RITHOLTZ: So I want to go over the fund’s objectives which is to quote “generate equity like returns over the long term while taking less risk than the market and avoiding permanent impairment of capital.”
Hey, everybody wants to do this, you are one of the few who actually have, tell us how you manage to accomplish that.
ROMICK: Well, we invest across the capital structure with this goal of delivering attractive risk-adjusted returns. So on stock, stressed and distressed corporate bonds and private credit occasional preferred stock, et cetera. When it comes to stocks, we will own the more commercial and the evergreens, that is the commercial call them the dollar bill strategic discounts..
RITHOLTZ: Right.
ROMICK: And those companies whose businesses you know, on the other hand that are more evergreen that businesses should be solely better a decade from now, it’s really a function of price and risk reward that will dictate which direction we go for these ever greens versus more commercial opportunities. But we try everyday to know the better businesses in the world and own them should they ever trade down for one reason or another, we will be there to pick them up.
And what we also own is lesser quality but still growing businesses if their stock prices offer attractive upside relative to the downside and then we have our debt investments where we – all we care about is getting our principal back in maturity but you also generate an equity return along the way.
That really speaks to more to our philosophy and then and then our process is guided by thoughtful research of the underlying opportunity as we really try to ascertain the value of the business of the asset, and that’s got about a lot of reading many conversations with management competitors, industry experts and so forth and then we know will go about those are financial models.
Our models don’t suggest what we know what might happen in the coming quarter or even 2022, but over the next few years, we want to have a view as to what this business might look like in a low base and high case.
And we want deep investment in that business — that equity to – that we are going to be buying up in that business to be attractive in the base case and have that upset optionality on the in the high case and not get hurt too badly in the low case. So we really try and create these boundaries, these governors as we look at each individual investments in the portfolio.
RITHOLTZ: So I’m trying to figure out how to describe your style of investing and it’s pretty challenging, I’m looking at some of the holdings in your top 10 so you have Alphabet and Facebook on the one hand but on the other hand you mentioned AIG and Citigroup, is this value, is this growth, it’s pretty hard to put you into a style box.
ROMICK: Yes, I think that there is a problem with style boxes, because we don’t make a great distinctment in growth and value, show me a growth investor that argues what they bought isn’t a value, but then also you can stick a company that trades at call it 40 times earnings but if it’s growing 30 percent a year for the next five years and into that five-year period, it’s trading 10 to 11 times earnings or thereabout. So to us, value investing is just to invest with the – with an appropriate margin of safety, buying a business or asset at a discount.
In the past, that margin of safety might have meant protection you know, came from the balance sheet in the more in the most traditional Graham and Doughty (ph) kind of definition, you know, buying below book value, below net net working capital, and the business might have non-earning assets that could be monetized et cetera.
Today, for us, it more likely means protection that has to come from the quality of the business, you can get sucked into what you think is a margin of safety because — you’ve got these you know what appears to be strong book value — you’ve got no hidden assets but the business isn’t good at the end of the day, the — you’re probably going to have a challenge, take Sears as an example, there are a lot of value investors who owned it believing that management could turn the business around, but if not they are protected by lots of great real estate’s most powerful brands like Kenmore and Craftsman.
However as we now know, management wasn’t successful and much of their great asset-base was mortgage are sold off, with that capital as that reinvested back in the business and then you know when it’s a time that it came to a point in time where people realized ex post that they were ever burning the timber from the house.
So to us, an attritional value investments you know are you know, all mediocre cyclical business that were temporarily out of favor and offered investors the opportunity return to more normal earnings but many of those businesses have been disrupted by new technologies and didn’t offer the margin of safety they once did.
So we’re very mindful of whatever we own, it really does have to be growth, it doesn’t have to have go-go growth we owned a couple cement companies that have global franchises that we think cement is going to be here for a long, long time. They are not go-go growth business certainly, but those are businesses that we think that offer attractive risk-adjusted returns over the — over the next number of years.
And you mentioned you know, Google and Facebook, but even those investments were initiated point in time when there is bad news surrounding them, Google back in 2011 when there was fear that their advertising business was going to be impaired which is bulk of the revenues, was going to be impaired because of a recession as the world is beginning to unwind as what happened in Cyprus is infecting in know Europe and Greece and the rest of Europe and the stock traded and the stock traded down, Facebook traded down a few years back because the Cambridge Analytica scandal and people were worried about it — its business prospects.
And so a lot is you know, entry into two very good businesses that we’ve owned ever since.
RITHOLTZ: So you mentioned you by some nonpublic distressed debt, are you purchasing anything on the nonpublic side of equities?
ROMICK: So yes, we do. We do own some privates in the portfolio but they are very small and because we are a public find and we are responsible for returning capital to investors when they — when they want it back.
But on occasion, we make investments in certain private investments and opportunities you know Epic Games is an example we also have various private credit and positions in the portfolio that we’ve made over the years the last decade we put you know, 800 million or so out you know in the private credit that have delivered the returns of you know, give or take, you know, 14 percent into the fund and these are secured first lien asset-based loans and that — or something different that not a lot of mutual funds do.
Again, I don’t want to suggest that this is — that the engines in the portfolio, these are our investments that that end up in the periphery again because the of their illiquid nature and the fact that we are a public fund.
RITHOLTZ: So last question about the funds, you are located in Los Angeles, a lot of what you’re covering seems to originate on the East Coast in New York or in Silicon Valley, how does being located in LA affect your worldview?
ROMICK: I had really thought about LA affecting my — my worldview until you just asked that question. I — I do think that, you know, just in general the world has gotten — has gotten smaller because of — of the information that’s available at your fingertips, you know, across the Internet. And that’s certainly has made it easier.
But living in Los Angeles, I don’t know, has affected by my — my worldview to — to any great degree. I don’t know if I would think differently if I was, you know, living in — in Chicago or New York. I haven’t really thought about it (inaudible) to be honest how my view has been impacted by living here.
RITHOLTZ: Hey, that’s a fair answer. I’m just trying to get a sense of — of your philosophy and — and how, where you’re situated might somehow filter into it.
So, we talked a little bit about fixed income and especially in the high-yield world where you’re taking a lot of risk for almost no reward. What do you think about the state of inflation here that seems to have been a giant topic the past couple of months? Does this affect the way you invest? I noticed you guys don’t really make much of a inflation forecast. What’s the impact of — of inflation on your thought process?
ROMICK: We think that with the way the stewards of — of — of –of capital at the sovereign level have been acting in the last number of years really to a great degree since the great financial crisis, there is — there is this financial alchemy that’s going on that people hope that — that — that the academics have have it all figured out, that they’re going to give engineer this soft landing and — and be able to control the inflation in a way that and — and drive growth at the same time that is going to all in perfectly.
And if things tend not to be quite, you know, so perfect out there in the world and — and the — we’ve learned to expect the unexpected, and we don’t know what is going to happen, we don’t know whether they’ll be inflation or how much inflation there might end up being, we think that there is reasonable prospects of it, you know, certainly.
But, you know, might there be a deflationary path to inflation, that could be the way we get there, where the — where the kneejerk response is to continue to — to, you know, print more, borrow more, and then stimulate, stimulate with a — with a want and disregard for — for the future ramifications of — of what it might mean to fiat currencies, you know, or — or — or the economies or — or inflation down the road, but looking for that near-term bump as these policymakers and academics are — are really thinking about what’s happening right now as they — as they seek to be reelected or reappointed.
So we don’t know what’s going to happen, but we create a range of outcomes. And we think that, you know, was we look at them. It’s more appropriate to be more invested than not if you’re looking out where the world is going to be, you know, five, 10-year since.
RITHOLTZ: So that race is really interesting issue. You refer to the response from the fiscal response from governments and the monetary response from central banks. Are they in the process of changing what bear markets are going to look like going forward? And what I mean by that is have investors learn to anticipate fiscal and monetary stimulus?
ROMICK: I think the world is certainly trying to do that. We hear it. First Pacific advisors know we can’t anticipate. We just try and create a portfolio that’s robust to multiple outcomes that doesn’t go too hard one direction or another believing that, you know, that we really have the capability of identifying what the macro environment will look — going to look like prospectively. There’s just way too many moving parts.
When you put me in a room with a — with — with John Maynard Keynes, I’m going to, you know, come out a, you know, Keynesian economist, right? I’m going to be a believer, you know, same with, you know, put me in there with a monitor supply side or, you know, who or whatever. It just there’s — these guys have all the arguments down. And — and I’m just not, you know, well-versed enough. And I — I don’t believe that that anybody really has that capability.
And, in fact, if you were to go back and — and look at — at the projections made by economists for just the coming year for what GDP was going to be …
RITHOLTZ: Right.
ROMICK: … they’re — they’re rarely right. Somebody gets it right, but nobody is right consistently. And sometimes they’re — they’re wildly wrong. And you look at — at — at — at people like Alan Greenspan who didn’t think that we were, you know, in a recession in the early, you know, in the early part of those, you know, or — or Bernanke. It is the — they didn’t expect the great financial crisis. These things weren’t anticipated.
And so, we don’t hang our hat on — on listening to them or trying to — to anticipate what might be a lot of things might be. More things might be (inaudible) be, so we just try and put our heads down and — and believe that — that you know what, down the road that, you know, Google is still going to be a good business and we’re not paying — even today at current prices, you know, if you adjust for the cash, you — you — you adjust for their non-earning assets, you would just for third non-earning assets, their moonshots.
And — and the — the stock is not so horribly expensive. It’s certainly as cheap as it was on an adjusted basis. We bought it back in ’11. It was in the early, you know, early — low rather teens multiple, you know, adjusted (inaudible). But these are companies with comfortable owning, you know, through this.
RITHOLTZ: So that’s kind of interesting. What other investment opportunities today are you excited about? You mentioned overseas. Is that ex U.S. developed? Is that emerging markets? What is catching your eye in the present environment?
ROMICK: You know, we — we — it’s — it’s more — it’s more developed economies while there’s some emerging markets in it. It’s not any one company or one industry, you know, specifically. There is just — there — there’s a host of different, you know, businesses that we own, you know, outside the United States. There’s some businesses that we own, you know, inside the U.S. that are less economically sensitive as well that — that make their way into — into — into the portfolio, that are again — I’ll give you an example of a more commercial opportunity we’ve owned for, you know, since last year, and it didn’t go down because of the pandemic. It went down for — for idiosyncratic reasons.
It’s — and I don’t want — and anytime I mentioned idea, I don’t want to suggest this is like our favorite idea or the only idea, this is just to be — meant to be emblematic of — of — of — of philosophy and process. But we own, you know, FirstEnergy, which is a — a pureplay regulated transmission distribution utility with one of the largest networks in the U.S. I mean, six million customers across five states, you know, starting in Ohio and kind of moving east towards the mid-Atlantic.
Now, it’s core utility business is better than average, which mean it would test — you know, I mean, it can be determined as a higher than average, you know, ROE. It’s got more regular transmission distribution assets rather than the more risky business of non-regulated independent power production. And for the most part, they’re in regulatorily-friendly states with lower than average competition.
So, we also, you know, look at like the utility industry just — just as an idea, just as a — as a construct because we think there should be underlying demand for increased transmission and grid modernization, you know, over the next number of years. So — but, you know, the utility industry is — is, you know, the index trades about 19, 20 times earnings, you know, thereabouts.
But this company, you know, last year, you know, who got (inaudible) some bad news. In Q1 of 2020, you know, FirstEnergy got caught up in a bribery scandal that alleged, you know, illegal campaign contributions following around $16 million to the former Ohio Speaker of the House in the hopes of passing a bill that provided some, you know, subsidies for nuclear business, you know, that isn’t — that you don’t even own anymore.
And as a result, you know, if what, you know, how the government might or in the regulars might come at them, it caused the stock to drop by almost half from the February 2020 high. And that cleaved off about $13 billion market value. And if you were to adjust it for the decline in utility index because that had gone down, you know, at that point of about eight percent as well along with the, you know, coming down with the pandemic that would — adjusted basis means about $10 billion to $11 billion of value, you know, was taken out adjusted for the decline in those utility indices.
And so, we — our workers really centered on — on two things like, one, how good is the business and two, you know, what — what might be the penalties be. And so, we worked that we did, you know, on the business in conversations with competitors, industry experts, and utility analysts gave us a comfort level that the business was as advertised as good as we thought it was.
And then with respect to the — the fine that was likely to occur, we thought it would end up being manageable. So, they were federal sentencing guidelines that are fairly, you know, formulaic. And so, we used history as a precedent and looking at lots of — of different — of fines have been paid in the past. And there’s a base case fine, and then there’s a — a culpability multiple that gets attached to that.
So, we — indeed, as we triangulated these — these other fines and — and — and the multiple, we kind of looked at that maybe they fine (inaudible) some place $150 to $400 million. I remember I just said that the business declined $13 billion, maybe $10 billion to $11 billion adjusted, you know, relative to the utility index.
So even in a worst-case scenario of $1 billion, it’s still, you know, just one-tenth of what the stock in a price decline that — that had been — been seen by its shareholders or borne by its shareholders. And so we felt pretty comfortable that the adjusting for a base case fines and — and the stock trading back to market multiple in the next couple of years, again looking down the road that buying the business at 11 times (inaudible) with a five percent dividend yield was pretty attractive relative to the — the utility index that was trading at 19 to 20 times earnings with — with a — just a few percent, you know, dividend yields.
So, as you got through the scandal, we thought that the — the stock was trading in the high 20’s, you know, could end up being, you know, trade in some place in the –in — you know, in the low 40’s to low 50’s.
RITHOLTZ: And what’s it look like today?
ROMICK: I mean, the same story still (inaudible) — still in the midst of this, the stock prices moved up, you know, from the — the high 20’s to the higher 30’s. And the — the opportunity still exists for that same upside. Nothing has really changed. They’re in the — in the process of — of working through the, you know, the — you know, whatever is going to happen regulatorily with the fines. We just don’t know where it stands, you know, today. We’re not going to know until we know.
But as we’ve looked down the road, we — it’s going to be settled just like I argued before that people would travel again. People would stay in hotels again. And Marriott, you know, would not have an occupancy that was — was — was going to be, you know, close to zero for a period of time. You’re going to end up with a — a more normal environment, you know, for FirstEnergy, you know, and — and — and all its markets, in Ohio, Pennsylvania, you know, et cetera.
RITHOLTZ: That’s really intriguing. So, margin of safety, clearly, a key part of your investment approach. I’m going to assume nothing in 2020 changed that philosophy. So that leads me to the question, what is your takeaway from your experience during the pandemic? What’s the lesson that investors should have learned last year?
ROMICK: Investors, you know, every time, you know, they should learn this. It’s — it’s the last same lesson, right? It’s — it’s thinking what the world looks like down the road, not what it might look like in the next six months, three months or even a year or two. But what’s it like down the road?
I mean, if you’re buying a business, if you care about it twice, the day you buy it, the day you sell it. So if you’re not going to sell that business for five, 10 years, why do you care if the stock goes up or down in the next couple?
RITHOLTZ: No doubt about that. Our last question of this segment I want to throw you a little bit of a curveball, I — I asked you earlier about LA. I — I was kind of surprised to learn you’re a surfer. Tell us a little bit about that hobby.
ROMICK: Oh, I’ve got lots of hobbies. I’m — you know, I’m a — I’m a — I’m a jack of many trades and master of none. I’m — I — I enjoy it. Look, I swim competitively for college. I’ve always enjoyed, you know, the water. I enjoy swimming in a pool, enjoy swimming in the ocean. And — and I never — I used to lifeguard the beach. There’s a summer job when I was in college and — and — and learned to surf. You know, as I said, I’m not very good, but it’s nothing like just being up there in the water and — and dolphins swimming around you. It’s pretty — it’s pretty peaceful.
And to, you know, pick up a wave and — and maybe have a dolphin riding with you, which has happened on just one occasion in my life, but I keep trying to — trying to repeat that is — is a pretty, you know, beautiful, you know, spiritual experience for me. I find it incredibly peaceful.
I spend more time now, you know, surfing behind a boat, you know, on a lake …
RITHOLTZ: Right.
ROMICK: … because I don’t have to compete for waves. And — and — and that’s been, you know, it’s just — it’s a lot of fun.
RITHOLTZ: I don’t know if you’ve seen the videos of all the young great whites that like to go surfing with surfers in a very non-aggressive way. Apparently, it’s different when they’re larger and older, but when they’re young, they — they seem to be pretty chill. Some of the videos I’ve seen on YouTube taken from drones are just astonishing.
ROMICK: Oh, yeah, they’re — they really are. And they are — it’s — it’s disconcerting, you know, and (inaudible) competing in the ocean, you know, swim races, you know, once or twice a year. And I remember once watching one of those drug videos of a gray white kind of — underneath the — underneath the — the crowd of swimmers, you know, kind off the South Bay or Hermosa or Manhattan Beach in a race. And I’m — I just thought to myself I’m like that’s the first — I don’t know what I would do (inaudible). I just tried and pushed that out of my mind.
I don’t care if it’s a big great white or a small great white, Barry. A great white is a great white. I’m not going to be real thrilled.
RITHOLTZ: See, I’m going to — I’m going to push back against you on that. If — if the choice is a big great white or a small great white, I’m going to go with the small younger one. They really seem to be — so, by the way, if — if people are still listening at this point, go to YouTube, Google this. It’s astonishing. They’re not like 100 yards away, they’re inches away. They’re — it’s almost like they’re dolphins playing with the swimmers and surfers. It’s really amazing to see. But that said, you know, it’s a little frightening if you’re out there on a regular basis.
ROMICK: Barry, I’m going to go on record as saying that I’m not going to spend a lot of time determining how big that great white is.
RITHOLTZ: (LAUGHTER)
OK, that’s — that’s fair enough. Let me — I know I only have you for a certain amount of time. Let me jump to some of my favorite questions that we ask all of our guests that are not surfing-related and — and start with, tell us what you’re streaming these days. Give us your favorite Netflix or Amazon Prime or — or even podcast you’re listening to.
ROMICK: Hey, I don’t — I don’t actually listen to — to a lot of — I guess, I don’t do a lot of streaming other than what, you know, more — more entertainment-related history. I mean, I tend to, when I’m in the gym working out on — you know, on my stationary bike, I do a lot of cycling, you know, I — I tend to, you know, throw in a — a documentary and — and something there with subtitles and — and just kind of — I watch it. It can be a on a host of different topics. I love music and — and — and frequently it ends up being as something related — related to that.
I spend more time, you know — you know, reading non-fiction and then try really hit drive a lot of — of throughput there to the best of my ability. I say the best liability, there’s some books just end up being a little bit — a little bit denser than others. And I find myself, you know, sometimes struggling through to — to get onto the next book.
RITHOLTZ: So, we’re going to come back to books in a minute, but now I want to ask you, tell us about your mentors who helped shape your career.
ROMICK: Well, the — the one person really, you know, shaped my career I mentioned earlier is — is James Naven (ph), goes by Jeff (ph). And he was my — my first boss, and he is the one who introduced me to a lot of people, you know, early on when I was just starting out in my early 20’s where I was able to sit down with, you know, his good friend, you know, Lee Cooperman and asking questions, and learn from — learn from him, and — and have him, you know, be at the Teledyne annual meeting, introduce Henry Singleton and have dinner with him afterwards and talk about his experience investment in Teledyne, you know, back in the day. And that — that really was incredibly educational.
And then I remember once he — he had me — you know, we drove down to Laguna beach to — this is a guy who I’ve never heard of, I just couldn’t Google somebody back then. And — and again I — I hadn’t been in the business that long at this point in time. And I sit down at — at the lobby bar of the Ritz — Ritz Hotel in — in — down in Laguna Beach. And there’s a guy who shows up with an ascot and — but seemed like paisley pajama bottoMs. And it was — it was — I never saw anybody dressed like that, and it was Sir John Templeton. And I was able to have a tea with, you know — you know, Sir John Templeton and — and listened to his, you know, life experiences and talk about investing. And to be thrown into that kind of — of world at — at a — at a very young age has — has made me, you know, incredibly, you know, made me recognize as incredibly fortunate.
RITHOLTZ: To say the very least. I want to circle back to something that you mentioned in — in my earlier question, which is you said you tend to listen to music related or watch music-related streaming. You — you want to give us any examples?
ROMICK: I mean, I’ll — I’ll — I’m going to listen to like, you mean on a podcast list and into that something called Song Exploder.
RITHOLTZ: I love Song Exploder, so good.
ROMICK: I just — I love the — I love the — the entomology of — of the song. I — I like, you know, reading the Wall Street Journal, you know, column that really breaks down the — I forget what the — the title of that column is and (inaudible).
RITHOLTZ: A-hed, yeah. If you like — if you like Song Exploder, have you played with — it’s on YouTube, something called Polyphonic?
ROMICK: No, what’s that?
RITHOLTZ: So, it’s just a guy who puts videos up discussing sort of the musicology of specific songs, and bands, and artists. And you might find it kind of fascinating.
If you’re at all intrigued by why John Bonham of Zeppelin, instead of tracking the bass player, tracked the lead guitarist, and what that did to their music and a whole bunch of other crazy stuff like that, it …
ROMICK: Oh, I love that.
RITHOLTZ: Oh, then you’re going to …
ROMICK: That’s not my alley.
RITHOLTZ: Then I — I just …
ROMICK: I’m also — I’m — in addition to being a frustrated surfer, I’m also a frustrated guitarist.
RITHOLTZ: All right. Ao you’re going to get a — you’re going to have a huge kick out of this polyphonic on — on YouTube.
So now, let’s talk about everybody’s favorite question. What are some of your favorite books? What are you reading right now?
ROMICK: Well, I’ve — I mentioned the — you know, it’s sometimes struggling to get through books. And — and the reason I (inaudible) this is fresh in my mind because I’m sitting on my night table and I’m about three-quarters way through it is is Walter Isaacson’s book, gene editor on Jennifer Doudna. And it’s just — it’s a — it’s a little bit dense because you really try and — as I’m really trying to understand, you know, the — I have a whole list of books that are tied to — to, you know, to health care and health tech — med tech and — and the history of — of — of biotech. And I’m just trying to get a — gain a better understanding of that industry.
And so, I really enjoyed reading nonfiction to try and inform my view of — of the world, so that’s one that I’m reading now, but — and it’s called “Code Breaker.”
And — but I — I read a lot of these books that — that try and inform my view, and that includes like the “Outsiders” by William Thorndike, which is, you know, a, you know, CEO profile. So that would include, you know, John Malone, Henry Singleton, Tom Murphy of Cap Cities, Warren Buffett.
And it really just — you know, reading about these people, what they — what they’ve — what they accomplished historically in their businesses and help some form of view as I speak to managements today. I — you know, one of my favorite books of — of all-time really is “Run Churnouts with the Warbrookes (ph),” because it’s an expensive history of — of financing of couple of world wars and — and a — a Jewish family that, you know, made its way from germinate (ph) to England to the United States. And — and I find that, you know, incredibly interesting as well.
And sometimes you — you — you — you — you — you — you read the books, right, read the books like kind of, you know, what did I learn, what are my takeaways and, you know, like a red twilight in the desert 20 years ago. And — and they had the belief that — that from reading Matt Simmons book that — that they — we’re going to have — have a problem with a — provide energy into the world with — with — because fossil fuels were — were harder to come by as it relates to oil specifically.
And, you know, it looks clear that didn’t come to pass. We — you know, a couple of things have happened since. And as you have to, you know, be willing to — to adapt. I mean, we had obviously a big increase in renewables and you also have the, you know, the oil sands and — and (inaudible) shelf formations that have created a lot more oil out there than — than people have expected. Meanwhile, you have all said the rise of — you have — we have the rise of — of electric vehicles and such that — that are going to put a crimp in future demand. So, look, you have to adapt in, you know — to — to changes in the world.
I’m spending a lot of time reading about health tech, you know, which includes this in med tech and biotech because I believe in some of the great businesses, you know, and fortunes will be created over the next 20 years are going to come out of that. We mapped the human genome 20 years ago, but it was like identifying the — the parts to a car.
For the last couple of decades, we’ve — we’ve been trying to figure out how those — how the — the parts of the car work individually in — in an integrated fashion. And just now we’re really beginning to see some of the fruits of that, and we’re going to see a lot more in the future.
RITHOLTZ: Really, really interesting. What sort of advice would you give to a recent college grad who was interested in pursuing a career in asset management?
ROMICK: I — I think that — I would say the same thing I’ve — I’ve related earlier is in terms of having that longer-term view. Whatever you do, whatever decision you — you make, make sure that you’re making the decisions with a kind of a — a five to 10-year, you know, or seven to 10-year rolling, you know, time frame. It’s going to allow you to make better decisions today.
It’s going to — you know, you’re going to be more willing to absorb some of the bumps in the road, you know, today if you understand that you’re going to be better off in the future and the future for it. And I would say in addition, you know, do something you enjoy and make sure you’re good at it and work really hard.
The — the last thing I would probably leave somebody with is — is — is — is do well by doing good, right? I think that one of the things we realize, you know, today in — in — in — in the world that it’s not an uncomplicated pace. There’s a lot of people who have — who have been mistreated, you know, over the years. And, you know, we can — we can, you know, try and make the world a little bit better. So if you can do that while you’re investing, you know, all the better still.
RITHOLTZ: And our final question, what do you know, about the world of investing today that you wish you knew when you were first getting started back in the 1980’s?
ROMICK: Yeah, I really wish I had better anticipated the world of disruptive change. The — the technological innovation that has taken place has — has upended the economics of so many different industries. And whether it be online, retail, you know, which has changed the economics of brick and mortar retail or streaming video content and video on-demand, destroying video rental and forever changing movie theaters, or single-cell genomics that have developed on the back of — of having mapped human genome and now creating new therapeutics, you know, outloading (ph) what’s been accepted today or renewable energy solutions that are gradually displacing fossil fuels.
And we’ve — we’ve successfully avoided most of the disrupted industries, but that’s like growing that, you know, that our boat didn’t sink. It’s not supposed to sink. We would have enhanced our performance, have it and more willing to pay up at least a multiple turn or two on some of the better businesses in the world whose paradigms are — are more winner take all or winner take much.
So we didn’t buy Amazon. We — we thought we were doing pretty good by — by not by selling our retail out in more than a decade ago. But we just didn’t buy, you know — Amazon, even though we’d look at it, we just didn’t look at it closely enough, and that has to solve and go to the mistake bucket. So that’s what I wish I knew 30 years ago.
RITHOLTZ: Really quite fascinating. Steve, thank you for being so generous with your time. We have been speaking with Steve Romick. He is the Managing Partner of First Pacific Advisors, an asset manager running over $26 billion in various assets.
If you enjoy this conversation, check out any of our prior 400 such interviews. You can find those wherever you feed your podcast fix — iTunes, Spotify, Google podcast, et cetera.
We love your comments, feedback and suggestions. Write to us at mibpodcast@bloomberg.net.
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I would be remiss if I did not thank the crack team that helps put these conversations together each week. Tim Harrow (ph) is my Audio Engineer. Atika Valbrun is my Project Manager. Paris Wald is my Producer. Michael Batnick is my Head of Research.
I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
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