article , video 12-01-2014

A Healthy Skepticism is Key to Managing Risk

At Royce, our more-than-40-year investment approach is built on the idea that preserving capital is just as critical to successful long-term growth as growing it. Portfolio Manager Jim Stoeffel talks to Co-Chief Investment Officer Francis Gannon about his auditing background and how that experience influences the way he assesses risk. 

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Francis Gannon: Jim, how do you describe yourself as an investor?

Jim Stoeffel: I'd say probably the key aspect of investing for me is really risk management, and it really stems from my background. My formative years were spent as an auditor and a CPA including, interesting enough, a period of time doing fraud audits.

I'm a bean counter, I'm a numbers wonk, and I really like to get as deep as I can. But there is another aspect of auditing that's known as a healthier skepticism, and I think you really need to bring that to bear when you're talking to companies, when you're looking at the financial statements, and to me it goes to what we do at Royce—to have that skepticism, to make the management teams prove what they say they can do. Because every management team comes in with a story, sounds good, everything's great. You know, I think you really have to approach it with a healthy ear of skepticism, which I think is good.

Francis: So let's talk about risk. It's a big, broad topic; very topical in today's environment. What are the things you do to mitigate risk when you're looking at a company?

Jim: Well, the key one, obviously, is the balance sheet. But really I'm looking for companies that have high returns on invested capital, and it's sort of twofold.

In my opinion, it's sort of the number that encapsulates everything about the business: the economic moats, the competitive moats. And the high return on investment allows you to, obviously, potentially get more from the equity. The only way you can really get true equity returns is, obviously, if you're investing at a rate higher than the cost of capital.

So really, looking for the return on invested capital and really going through the financial statements are key ways for me to attempt to mitigate some of the risk.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the person speaking 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 small-cap companies may involve considerably more risk than investments in securities of larger-cap companies. (See "Primary Risks for Fund Investors" in the prospectus.)

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