Why Investment Discipline Matters | Royce
article , video 06-29-2017

Why Investment Discipline Matters

Portfolio Manager Bill Hench provides a detailed look into his deep value investment approach and why maintaining discipline is so critical.   


How do you maintain your investment discipline?

Maintaining a discipline is something everybody talks about, but is often a lot more difficult than it would seem. With us, you know, the hardest part is letting things go, right?

When things work it's wonderful and you want to hold on to them because things are working so well and the stocks are reacting positively, but we do have a mandate to keep our portfolio cheap, so thus when things start to move up and start reflecting what we think is fair value, we're going to start unloading them.

And in some cases, especially in markets where you've got nice GDP growth or when the direction is positive, you're going to see those stocks continue to do well. They turn into momentum names and you don't want to look at them a couple of months later because if they truly are momentum names, chances are they're going to be a lot higher than where you sold them at.

But that's someone else's game. Our game is to take that money and hopefully find the next name that we'll have to worry about being a momentum stock.

How do you decide when to sell?

When we had disappointments with investments, it usually happens during that building process where we're slowly getting into a name. And the thing that is most common is that there's a deterioration in the financial statements that is greater than we thought.

So, in other words, we're buying them knowing that things aren't going to get better in the short-term. However, we are also looking for sort of an improvement that comes over time, so if something changes that or if things look materially worse than they suspected they would be, we're going to exit the position.

How critical is company management to you?

You want, essentially you want management to do what they say they're going to do, right? So, with us it's important because many of the names that we buy are in the short-term going through a difficult period, so what we're really hoping for and looking for is an explanation of how the management team is going to deal with that difficulty and what it is that's going to happen, is it going to be market forces, is it going to be something they have to do? What exactly has to be done and can they do it? And that's what we're looking for.

Why do you think you have been able to remain disciplined when others haven't?

I think the one thing that we can say is that we've lived through many cycles, so we have the great teacher, which is experience dealing with these markets, dealing with liquidity, especially during tough times, could be our best friend, right?

It could be the time where we really build portfolios that have those really great qualities that we need, which is, number one, being cheap, but just as importantly, having those attributes that will make them perform really well when the markets turn.

So it's difficult to do because you have to constantly fight off what you think is the smart thing to do, right? You're constantly fighting off trying to jump into something that looks so cheap and so wonderful because no one else has recognized what a great value it is and then conversely, when things start to do well, you have to resist that desire or temptation to let it go as it gets, quote, unquote "expensive."

But what we found after doing this many, many times and cycle after cycle is that you have to do this gradually and you have to live with that bad liquidity and, and make it an ally instead of an enemy.

Having lived through these things before, you realize that things truly go down for reasons other than fundamentals and it could be liquidity, it could be people making decisions just to exit this part of the market, whatever. A thousand reasons to sell, right, but there’s really only one reason to buy.

It is being patient that really helps us especially in the bad markets and I think that no matter how many times we hear about the markets changing, they still pretty much remain the same.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of April 5, 2017 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Investments in securities of micro-cap, small-cap, and/or mid-cap companies may involve considerably more risk than investments in securities of larger-cap companies. (Please see "Primary Risks for Fund Investors" in the prospectus.) 



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