Romick Holds Cash Like Klarman in Top-Performing `Free-Range Chicken' Fund

Steven Romick says he aims to beat the market when stocks are falling and underperform by a smaller margin when they’re rising.

His $3.45 billion FPA Crescent Fund can buy shares as well as bet against them, purchase investment-grade and junk bonds, and hold almost half of assets in cash, a strategy Romick has compared to a “free-range chicken.”

His picks have worked for investors, with average returns of 11 percent a year in the decade ended June 30, better than 99 percent of the fund’s rivals, according to Morningstar Inc. Romick says his priority since starting the fund in 1993 has been to limit losses, rather than maximize returns, a view he shares with Seth Klarman, who made Baupost Group LLC the ninth largest hedge fund while holding as much as 40 percent cash.

“If you buy an asset and you feel comfortable with it even if the worst thing happens, then you are in a good position,” Romick, 47, said in a telephone interview from Los Angeles.

A graduate of Northwestern University in Evanston, Illinois, Romick began his fund at Crescent Management in Los Angeles. He brought it to First Pacific Advisors LLC in 1996 at the invitation of Chief Executive Officer Robert Rodriguez.

Rodriguez’s $993 million FPA Capital Fund is the best- performing U.S. diversified mutual fund over the past 25 years, according to Morningstar. The fund, which had about 30 percent of its assets in cash as of June 30, returned 9 percent annually over the past decade.

‘Sleep at Night’

“Steve’s constituency wants to earn a real rate of return and still sleep at night,” Rodriguez, who is on a one-year sabbatical from the firm, said in a telephone interview.

FPA Crescent has captured 80 percent of the gains of the S&P 500 in months when the index rose and suffered 55 percent of the losses when the index fell, according to Romick’s April 23 newsletter.

The fund gained 11 percent a year from its 1993 inception through March, compared with 8 percent for the Standard & Poor’s 500 Index of large U.S. stocks, according to the letter. FPA Crescent had a third less volatility than the market benchmark.

To find investments worth owning, Romick says he looks at the economy, industry and company trends, and meets the top executives of his major holdings. His firm recently hired Elizabeth Douglass, a former business writer for the Los Angeles Times, to help find assets off the beaten path.

Asset Allocation

Strategies where the fund manager is free to allot money to different asset classes are unusual for mutual funds. Most funds set strict limits on what a fund can buy, leaving the asset allocation to investors and financial advisors.

“We like outsourcing the asset-allocation decision to someone who does a good job of it,” said Steven Roge, a portfolio manager at R.W. Roge & Co., and an investor in FPA Crescent. Roge, whose Bohemia, New York, firm oversees about $200 million, said Romick has shown he can handle the freedom.

Hedge-fund-like strategies such as FPA Crescent’s may attract clients after a decade of disappointing returns by mutual funds, said Burton Greenwald, a fund industry consultant in Philadelphia. U.S. stock funds suffered withdrawals of $139 billion in the past 2 1/2 years, according to Morningstar.

Romick limited losses during the financial crisis by putting almost half his assets in cash. His fund lost 21 percent in 2008, compared with a decline of 37 percent for the S&P 500, Bloomberg data show. Romick had 45 percent of assets in cash as of Sept. 30, 2008, according to a filing with the U.S. Securities and Exchange Commission. The average equity fund has less than 4 percent in cash, Morningstar data show.

45% Cash

When the S&P 500 lost 38 percent from 2000 through 2002, FPA Crescent gained 46 percent, data compiled by Bloomberg show. Romick avoided crumbling technology stocks while holding cash and companies that climbed, including Houston-based oil driller Patterson-UTI Energy Inc. and crafts seller Michael Stores Inc. in Irving, Texas, he wrote in his newsletter.

Roge described FPA Crescent as “a hedge fund in disguise” because of its ability to move among asset classes.

Ronald Sugameli, whose Wellesley, Massachusetts-based New Century Alternative Strategies Portfolio has a stake in Romick’s fund, acknowledges that letting a manager roam and hold substantial cash carries risk.

“If the markets move and you are sitting in cash, you can easily get left behind,” Sugameli said.

Romick, who serves as First Pacific’s managing partner, said he currently favors energy stocks and large companies with global franchises, while avoiding financial and consumer shares.

‘Slow, Fat Pitches’

Two of Romick’s top 10 holdings as of June 30 were energy stocks, Los Angeles-based Occidental Petroleum Corp. and London- based Ensco Plc, data compiled by Bloomberg show. Ensco, a contract driller, has been among the fund’s top holdings since 2001, according to Romick’s newsletters. The shares have advanced about 66 percent since the end of 2001.

Romick sold Houston, Texas-based ConocoPhillips in the first quarter, taking a 15 percent loss on the investment. ConocoPhillips made poor investment decisions, said Romick, citing its participation in a $31 billion liquefied natural gas venture in Australia.

The fund bought Occidental because the company has done better than competitors at finding oil, he said. Occidental shares are down 3 percent this year.

When he doesn’t find investments he likes, Romick will hold cash until he sees “slow, fat pitches in our strike zone,” he told shareholders last year.

‘Preparing for the Worst’

Romick increased his fixed-income holdings to 32 percent on March 31, 2009, from 12 percent on Sept. 30, 2008, regulatory filings show. He bought junk bonds and distressed debt, he said, including issues from International Lease Finance Corp., the aircraft-leasing subsidiary of New York-based American International Group Inc.

Even as stock prices reached a 12-year low in March 2009, bonds were the better buy because they promised good returns with limited risk, Romick said.

“We believe in preparing for the worst,” he said. “Bonds were priced for a depression. Stocks were not.”

Klarman, founder of the $22 billion Baupost Group LLC in Boston, had a similar explanation for why he bought distressed debt at the height of the financial crisis. The move made sense, Klarman said in a May interview, because the bonds would have paid off even if the U.S. economy experienced a much worse decline, a scenario that probably would have sent stocks lower.

Lower Volatility

FPA Crescent’s lower volatility calms investors’ nerves and makes them more likely to stick with the fund, said Christopher Davis, an analyst for Morningstar. Research by Morningstar shows that in funds with big performance swings, “investors come in at the wrong time and bail out at the wrong time,” Davis said in a telephone interview.

The size of the companies in Romick’s portfolio has risen since the early days. The average weighted market value of stock holdings grew to $39.7 billion at the end of the second quarter from $1.2 billion in 1997, according to Romick.

Small-cap stocks sold for an average price-to-earnings ratio of 16, compared with 13.6 for large stocks at the end of June, according to Leuthold Group LLC, a Minneapolis research firm. Leuthold defines large stocks as those with a market value of more than $8.4 billion and small stocks as those from $255 million to $1.3 billion.

Changed Opportunities

The 18 percent premium investors are paying for small stocks is near the widest since Leuthold began gathering the data in December 1982, said James Floyd, senior analyst at the company. In 2000, small stocks sold at about a 40 percent discount to large ones, Floyd said.

“The opportunity set has changed,” Romick said. Big companies, along with being cheaper, are better positioned to tap into faster-growing markets outside the U.S., he said.

Wal-Mart Stores Inc., the world’s biggest retailer, was Crescent Fund’s fifth-largest holding as of June 30, Bloomberg data show. Shares of the Bentonville, Arkansas-based company, which gets about a fourth of its revenue abroad, are down 4.3 percent in 2010.

The U.S. economy will “muddle along,” Romick said, declining to give a more specific forecast. The economy will be held back, he wrote in his newsletter, by higher taxes that will be required to pay down the U.S. government’s budget deficit and by consumers who may take years to reduce their debt burdens.

Shorts, or bets that stocks will go down, represented 5.5 percent of the portfolio at the end of the first quarter, according to a May regulatory filing. Among the stocks Romick sold short were AutoNation Inc., a Fort Lauderdale, Florida- based auto dealer, and Capital One Financial Corp., a McLean, Virginia-based credit-card company.

Romick declined to discuss any of the stocks he has bet against.

To contact the reporter on this story: Charles Stein in Boston at

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