In an interview with CityWireUSA, value veteran Charlie Dreifus and manager of the Royce Special Equity fund discussed his sometimes-unusual approach to investing. Under his management, the $921.3 million small-cap fund has seen an 8.76% annualized return since its inception in 1998, compared to the Russell 2000 and Russell 200 Value indexes which have posted 7.67% and 8.25% respectively for the same period.
Dreifus likens today’s market to the 1970s, when there was also a small group of big companies (such as today’s “FAMNAG” companies) that a lot of investors believed were immune to volatility or bear markets, alongside excessive government spending, oil price spikes, and inflation just like today. When that market bubble burst, the recovery was long and painful, he told CityWire.
To mitigate that pain, one strategy that Dreifus employs is to establish a “margin of safety” by first establishing an inexpensive position in order to prevent the portfolio from being damaged by downside corrections. “When we can’t find enough such candidates…we automatically raise our cash percentage,” Dreifus says. When asked about accounting, Dreyfus pointed to his late mentor Abe Briloff who taught him how to utilize forensic accounting in order to deconstruct financial statements. Additionally, in his approach to value investing, Dreifus doesn’t believe that price-to-book should be utilized in searching for value stocks, saying that he would throw out the old-fashioned 1920s version but keep the 2000 version to gauge overall market risk.
One current holding that Dreifus highlighted in the interview is the watch company, Movado, a family-controlled business which is actively looking to expand and that he believes has an appealing valuation. Dreifus also discussed companies that are far off the beaten Wall Street-path—in the Rust Belt, to be exact. He said the area contains a wealth of good businesses that would meet the requirements for his “margin of safety” strategy, including accountability in both “transparent accounting and effective governance,” adding that “the cultural/ethical landscape is noticeably better in that region.”
One thing that his fund has never owned is a bank, and Dreifus says Royce’s “preference is for agents rather than principals.” He’s long believed—even before the financial crisis—that investors can’t know what the true value of a bank is until it’s shut down; their valuations are far too reliant on “the accuracy and adequacy of the loan or loss reserves.” Instead, the fund is evaluated over a full market cycle with both its ups and its downs which, given the holdings that the fund focuses on, “sometimes helps and sometimes hurts,” Dreifus says.