Chuck Royce: Economic Outlook and Current Opportunities by Royce Funds
Chuck Royce on continued M&A and the potential for increased CAPEX, how the decline in energy prices are affecting corporate America and creating opportunities in our favorite energy-related industries, high-yield spreads and the rising cost of capital, and his highest conviction theme for 2015.
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Francis Gannon: As a bottom-up manager, who really spends very little time top-down in terms of economic outlook, what are you hearing from companies? What are your thoughts about the economy going forward?
Chuck Royce: We’re hearing great stuff from companies, that they are very aware of their opportunities, their M&A opportunities, their capital expenditure opportunities. They’re not necessarily acting on them, but I believe they’re sort of well-organized for going ahead in both capital expenditures and M&A.
M&A has picked up dramatically. We are well into that cycle. We’re in the fifth, sixth inning of M&A activity, but it will remain strong. I think you’ll see more CAPEX, not necessarily in the energy world, but you will see more in the broader economy.
Francis: How do you think the massive decline in energy of the past several months is going to affect corporate America?
Chuck Royce: There’s a primary benefit for the consumer. We are a consumer economy. Seventy percent of the economy is consumer based. Now the rest of the world—the intermediaries of the world—are indirectly affected. Obviously in the sector itself they’re highly affected by the price of oil. That is a primary output price that is extremely important to their P&L.
But many, many companies serve the Energy sector. Many industrials serve the Energy sector. So there is a peripheral effect, which is affecting those kinds of companies. We’re heavily invested in the Industrials sector. So there is some crossover that has been negative.
Francis: So when you’re talking about the Energy sector, are there any industries that you’re finding opportunities in today?
Chuck Royce: We like our old favorites in the industry. We have always favored service companies, guys that are out there servicing the wells, providing the equipment for the wells, providing maintenance, providing all sorts of intelligence for the wells. Those are the areas we are likely to be adding to.
Francis: The story about corporate yields last year—specifically high-yield spreads—and the backup that we saw—especially towards the latter part of the year—and the cost of capital going up for many companies, how do you view that from a small-cap perspective?
Chuck Royce: I view it very positively. I view that as part of the path to the right way you price assets. Riskier assets should have a higher premium and the spread has widened, and I view it as a step forward towards normalization.
Francis: What is your highest conviction theme for 2015?
Chuck Royce: Well, my highest conviction hope is that correlations will continue to go down, therefore setting up more opportunities for active management.
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