Chuck Royce & Francis Gannon: Small-Cap Review And Outlook by The Royce Funds
CEO Chuck Royce and Co-CIO Francis Gannon reflect on 2015 and discuss the importance of the market’s gradual return to a normal range of returns, the uneventful Fed rate increase, the impact of widening credit spreads, and the role of active management.
See the video here.
Francis Gannon: What was the most notable aspect of our investment world in 2015?
Chuck Royce: I think it’s really important to understand what it was not. It was not the Fed finally raising rates. Everyone has focused on that in some absurd way.
In fact, it was the peaking of non-earning companies, which actually was much more significant. They have led the index. The index peaked a little before June 30th. The returns for that six-year period from the bottom were 18 percent from the index, and higher for the non-earners.
So it’s a big deal if it has reversed. We believe it has reversed.
Francis Gannon: You alluded to the fact that the big event for last year was really a nonevent, in terms of the Fed raising rates, because credit spreads had already been widening. How is that going to be affecting our portfolios?
Chuck Royce: Credit spreads have been widening for about a year-and-a-half, since the summer of 2014, when energy peaked. So as energy has had a sharp decline, credit spreads have widened, probably led by energy, but actually now across the board.
Credit spreads represent the true cost of borrowing, and they represent a much more important metric about returning to normalcy.
We believe returning to normalcy across the board is a healthy thing for companies and healthy for stocks.
Francis Gannon: As you look forward, how do you think the role of an active manager is going to play out? It seems like it should be taking on an increasingly more important role in investors’ portfolios. What are your thoughts on that?
Chuck Royce: Our definition of an active manager is that we’re managing risk. We believe our fundamental job is managing risk, and we are; we are placing bets on risk/reward all the time. That’s what we do.
In general, active managers do better where they’re adding and subtracting risk, and have a difference. In the other environment, when markets are going straight up, actually, everything you do to reduce risk works against you.
I believe the stress in the stock market creates specific opportunities for us. It is our job to take advantage of these short-term stress moments. We are absolutely doing that. We’re adding to our high-conviction stocks, and I feel very good about the year or two ahead.