Steven Romick: Volatility Into Opportunity
Volatility is more a measure of opportunity than risk. It lets me act on the visceral reactions of others. Value is the result of panic selling—irrational, illogical selling. To be good at what we do, we have to be strong financial analysts, strong business analysts, and pretty good psychologists. Our goal, over the long term, is to provide equity-like returns with less risk than the market. We want to make sure the odds and potential payoff are in our favor. If all we can make is 20 percent, but we could also lose 20 percent, then it's not that appealing. If we think we could make 60 percent vs. maybe losing 20 percent, that may be worth the risk. Since the economy is so jacked up on steroids, the fund has a margin of safety. I'm investing in companies we feel can be protected against inflation, with pricing power that could rise as fast as their costs.
The Stats: Romick launched the $4.1 billion FPA Crescent Fund (FPACX) in 1993. Its 3-, 5-, and 10-year annualized returns (3.1 percent, 6.4 percent, and 12 percent, respectively) are significantly higher than its category average.
Romick on his plays
Aon (AON) is the largest insurance broker in the world. They're brokers, not underwriters, so as the price to insure a building goes up, they'll make more money on their commission. The pricing for their products is relatively soft right now. At some point that will change and—given stable pricing and their cost-savings program—we'll make good money. We think interest rates are rising, which would be good for Aon. They have a ton of cash on the books that can be reinvested at a higher rate.
2. Occidental Petroleum
They're a large exploration and production company. It's a business we like because it will benefit from oil being worth more in the future. It's really that simple. Every year you pull oil out, you're depleting your reserve. You then have to buy oil to replace it. Five years ago the oil companies said they'd have X amount in reserves in 2010. Occidental Petroleum (OXY) is the only large oil company that has actually met their projected reserve replacement—the goals that they laid out for themselves.
3. Mortgage-backed securities
We're buying mortgage loans that originated from 2005 to 2007. The collateral (housing) has fallen out of favor, and some banks don't want to own the loans. We have over 1,000 loans across the country. One was underwritten in Detroit, where we paid $1,800 for the loan and have been paid back $2,500 already. If home prices decline 10 percent, we'd still make at least a 10 percent return—even if these people couldn't stay in their homes. These loans are 3 percent of the fund.
4. CVS Caremark
U.S. health-care spending is likely to grow faster than gross domestic product for the foreseeable future. Big chain pharmacies should continue to take market share from independent drugstores. We like CVS's (CVS) integrated model—it's a pharmacy and a prescription benefits manager. Prescriptions for generic drugs are increasing at a rate faster than branded drugs, and that's more profitable for pharmacies. CVS's valuation seems reasonable at less than 11 times its expected earnings for 2011.