The Royce Funds: A Culture of Discipline and Consistency by Royce Funds
President and Co-Chief Investment Officer Chris Clark provides a comprehensive overview of our firm, including a look at our more-than-40-year history, our contrarian, disciplined value investment approach, opportunities offered by small-caps domestically and abroad, mitigating risk, and more.
See the video here.
On September 10, 2014, President and Co-Chief Investment Officer Chris Clark addressed shareholders and investors at Legg Mason’s Investor Day 2014 in Baltimore, Maryland. Following a panel discussion on investing in a rising interest-rate environment—which was moderated by WealthTrack’s Consuelo Mack and featured statements from Chuck Royce, Isaac Souede from The Permal Group, and Ken Leech from Western Asset Management—and opening remarks from Legg Mason President and CEO Joe Sullivan, Chris talked about the history of The Royce Funds, our investment approach, long-term performance, small-cap opportunities, and more.
“What I’d like to do today is just give you an overview of Royce and a little bit about our history, some hallmarks of our investment approach, and then cover some current challenges that we have experienced, as well as talk about the opportunities that we see for future growth in our business.
“Royce was founded in 1972 by our chairman and CEO Chuck Royce, who you saw earlier today, and we joined Legg Mason in 2001. Subsequent to that, we have seen very strong and stable growth in our business over that time period and have enjoyed a very strong partnership with Legg Mason. We have 127 employees, 33 members of our investment team, nine traders, 24 portfolio managers; importantly, all very experienced, mid-career or higher in their level of experience, and certainly one of the hallmarks of Royce and one of the things that I think we are most proud of is the retention that we’ve had in our investment team. We’ve had a very stable investment team. When people find their way to Royce, they tend to stay, and it really has a very meaningful impact on our domain knowledge and the collaboration that we see across our fund lineup.
“Over that time, we have maintained our exclusive focus in the smaller-company asset class. I think Consuelo pointed it out; it’s been an asset class that has evolved quite substantially since Chuck had the idea back in 1972, but it’s one that remains very large, very evergreen, and very inefficient in its level of institutional coverage in the opportunity set of ideas. In fact, one of the things that we obviously value the most is that really, if you look across the cap spectrum, small-cap stocks tend to be the most self-determinant in their success or failure, which in our minds, over time, really rewards the work that we’re doing.
“The firm began with one open-end mutual fund. We are predominantly an open-end mutual fund company. That fund was Pennsylvania Mutual Fund, but over the years, we have diversified our business and now have a range of offerings, segmenting the smaller-company space both here and, in a smaller way, but an opportunistic way, overseas as well. We have 15 Featured Funds that represent about 80% of our assets. We have four closed-end funds, and our areas of focus range from concentrated, more focused portfolios geared towards higher-quality businesses, but we also invest in dividend-paying companies, total return orientation, opportunistic, and special situation strategies. We have more diversified portfolios and, again, over the past seven or so years have begun to develop our capabilities in international and global.
“The opportunity set, again, is very large, just to touch on that a little bit. We think of the small-cap space as really up to $2.5 billion in assets, but that represents about 4,000 companies, about $2 trillion in market cap. Overseas, that number jumps exponentially, where there are 25,000 companies with over $7 trillion in aggregate assets, sort of just exemplifying what we see as a real opportunity for us going forward.
When people find their way to Royce, they tend to stay, and it really has a very meaningful impact on our domain knowledge and the collaboration that we see across our fund lineup.
“Maybe we will turn now to our investment approach. We, first and foremost, are risk managers, and really I think if you think about when Chuck founded the firm, I mean in the early ‘70s and really coming out of that, the emphasis was on not losing money, and that really has been engrained in everything that we do at Royce. We approach our investments with an absolute return and an absolute valuation orientation. We try to take a contrarian approach in things that we’re doing, and when we think about risk management, we really start with balance sheets, we really start with building in a financial margin of safety in the investments that we make, recognizing that, over time, having the ability to weather events, having the ability to, again, invest often in businesses that have had high-quality metrics in the past but are going through some challenges, and making sure that we give ourselves the luxury of time to see our investment perspective play out, that balance sheet, that financial margin of safety, has played a very important role.
“We have a long-term investment horizon. Increasingly we’re finding that a very interesting arbitrage in the market, as the market is increasingly shorter term in its orientation, and so if you look at turnover in our portfolios, it’s in the 15-25/30% range, so we are committed to businesses. We are making long-term commitments to them, but importantly, we’re doing everything we can to build in two margins of safety, including the financial aspect of it. The second one would be valuation, so recognizing that to get those two in combination often something has to be broken, especially in a higher-quality business. That’s really the sweet spot in what we’re doing, and Chuck talked a little bit about the opportunity set that we see currently in these more higher-quality, cyclically oriented businesses, which are really the ones that have been most disadvantaged, as it seems we’ve been anticipating the next recession now for going on five years.
“We are bottom-up in everything we do. We strive to be as active as possible; you will see very high active shares in all of our portfolios, and we remain committed to that. We’re also benchmark and style agnostic, so our portfolios will look very different than the benchmarks that we measure ourselves against, typically the Russell 2000, micro-cap indices, the Russell 2500, and again, we don’t limit ourselves to the value component of the market, perhaps as defined by consultants. We look at the entire universe but certainly bring a very strong value orientation to that analysis.
We recognize that to outperform over long periods of time, you always have to be different than the market, and if you are different from the market, you are not going to perform in lockstep with the market, so that is something that we actively embrace.
“One of the things that this investment team—and