Chuck Royce: Energy, Interest Rates, And Risk Management Today by Royce Funds
Chuck Royce discusses some of the events that helped shape the first quarter and the prospects for risk management in a more normalized environment.
Watch the video here.
Francis Gannon: Let’s talk about the first quarter of the year. It’s been an interesting quarter. People seem to think the economy has stalled a little bit. Are you getting that sense from any of the companies that you talk to?
Chuck Royce: In the kinds of companies we talk about we are not hearing barriers to growth. We’re hearing issues that they struggle with: whether to go forward with CAPEX now or wait, M&A opportunities, etc. But honestly, the level of GDP growth I think is satisfactory to allow continued progress.
Francis Gannon: The way energy has come down, it has kind of reverberated through a lot of different sectors in the overall economy, some good and some bad. How are you thinking about Energy?
Chuck Royce: We’ve never been in the business of predicting the price of oil. We have had Energy weightings. Our Energy weighting has been slightly above average historically. We believe that Energy is a worthwhile area to invest in and we’ll continue to think in a positive way about Energy, but we’re not tying our analysis to the price of oil. The price of oil started down in August. It’s come down in almost a straight line and sort of perhaps stabilized in the last month or so.
But honestly, the effect is much broader than just in the Energy sector. In the consumer area it’s a big positive. That is just working its way through that sector as we speak. This time last year, energy was a lot higher priced. The majority of the consumers have an energy sensitivity to their driving habits. It’s been a negative in not just the Energy area but in many other areas that touch the Energy area.
Obviously, there is a huge amount of industrial activity that sells into the Energy region. They’ve been affected. The effect has been very strong. That is part of the ecosystem of Energy. We’re not, though, going to change the approach of how we look at Energy. We’re not going to try to tie it to energy prices. We’re tying it to the quality of the enterprise that will participate in the inevitable growth of that sector.
Francis Gannon: The other big topic in the first quarter continues to be this focus on interest rates and the Federal Reserve. How do you think higher rates are going to affect our portfolios?
Chuck Royce: Higher rates have now been accepted by the marketplace as coming. It’s a part of this road to normal that we very much believe is a positive for this country and a positive for the equity markets.
Francis: When we talk about companies in the small-cap space today, you and I often talk about real businesses; that we tend to invest in real businesses. They tend to be economically sensitive, cyclical in nature, and really haven’t benefited from some of the unintended consequences of what’s happened from a Federal Reserve standpoint. What are your thoughts on those opportunities in the market today?
Chuck Royce: We definitely invest in real companies. Real companies that make things, they produce things, they have factories, they have clients often worldwide. We’ve always been attracted to real businesses, and so we do our work around what a real business should look like. A real business should have positive cash flow and high returns. Those returns should be distributed fairly to us, the shareholders, and that’s what we focus on.
Francis Gannon: So how should investors think about active management and The Royce Funds?
Chuck Royce: Active management for us is risk management. Risk management is critical to everything we do. We believe it will have an enormous payoff, and that payoff comes more likely in a period of more routine returns: call it -5 to +10% as opposed to 15 or 20 or 25% returns. So a more normal period in returns, a more normal period in the interest rate structure. Both lead to, I think, a favorable period for risk management.
Francis Gannon: We cannot conclude our conversation about the first quarter without talking about the strength of the dollar, which has been quite powerful of late. And many people are attributing the outperformance of smaller companies on a year-to-date basis to the fact that they have less exposure to overseas revenue. How are you thinking about the dollar in terms of how you’re positioning the portfolios today?
Chuck Royce: Well, you’re right, in general small-caps have less exposure. Our better small-caps, our global-oriented small-caps, of course have some exposure. It is a very real phenomenon that’s going on. But I do not view that as a sort of permanent barrier to success, and I think it’s just another adjustment that many companies have to go through. We’re not using the price of the dollar to keep us from investing in some of these great companies.
