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Chuck Royce on 3Q 2011: Be Patient and Take the Long View

October 04, 2011
Holly LaFon

Holly LaFon

256 followers
Is the U.S. in a crisis right now? If so, what kind of a crisis is it?

I do not think we're in a financial crisis currently, but I would describe what's happening as more of an existential crisis—a crisis of leadership and political will that has drained people's confidence in our ability to make the necessary changes that would improve our economy. We are painfully aware of politicians' unwillingness to transcend partisan differences for the good of the country during a time of acute economic anxiety, which has the effect of increasing that anxiety. In fact, I suspect that the bear market was driven not so much by the situation in Greece as by the idea that both political parties are hostages to special interests and to the most extreme ideological fringes. However, I am confident that we will ultimately meet our challenges politically and economically. As for the stock market, I think that the current mood is so unrelentingly negative that even a small-scale positive surprise could shift the mindset of investors to a positive perspective.

What is most important for investors to know in these challenging times?

I would say that investors first and foremost need to be patient and take the long view. Of course, this is a perennial attitude for our investment staff here at Royce, but in highly challenging times like these it's even more important to stick to our core investment principles. I understand that looking ahead three to five years is not easy, especially after the Lost Decade for many investors between 2000 and 2009. Life has been difficult through much of the last dozen years. However, I would remind people who remain worried about when and where to invest that most U.S. companies made their way through the financial crisis very effectively, and their current financial condition is very strong. We are seeing a large number of well-managed businesses expanding their global presence, which in our view makes them well-positioned to succeed when the global economy begins to grow more quickly. These are the kinds of companies that we're buying as we look at the long term.

The small-cap Russell 2000 Index fell 25.2% from its 2011 high on April 29 through its low on September 22. What do you think are some of the implications of this sharp decline for small-cap investors going forward?

For us, it has yielded a number of very promising opportunities throughout the smaller-company space. The selling has been totally indiscriminate, which has allowed us to find what we think are terrific bargains in great businesses in all sectors and industries. Our goal when we buy a stock is to double our money in three to five years. Part of trying to realize that objective is to pay a price well below what we think a stock is worth. The downturn has created significant opportunities in companies that look attractively discounted and that we think could appreciate significantly over the long run.

Why is active small-cap management so important in the current environment?

To us, active management is synonymous with risk management. We believe that any edge we may provide is rooted in our ability to apply the tools of risk management—they are an integral part of our stock selection process. In the current market, which is teeming with cheap stocks whose low prices are very tempting, our focus on risk makes us discerning buyers. We never buy stocks just because they are cheap. We buy because we see what we think are well-run companies trading at attractive prices, businesses that possess the financial strength to overcome what is hopefully short-term adversity. Strong balance sheets, high returns on invested capital and the ability to generate free cash flow are the kind of traits that give us some assurance that stocks whose shares have been falling have what it takes to bounce back. We have always thought that, sooner or later, high-quality companies should flourish. Our relentless search for quality helps to set us apart and, I think, gives active small-cap managers like us a long-term advantage.

With all we hear about the advantages of developing economies versus developed ones, how do you see the long-term prospects for U.S. companies?

I think the long-term prospects for the best-managed U.S. companies are very bright. Over the last several years, we've seen the smartest companies, including many in the small-cap world, make the most of opportunities in the global economy. We've also seen many U.S. firms manage their businesses very intelligently during difficult years, so we feel very positively about their prospects.

Important Disclosure Information

Chuck Royce is President, Co-Chief Investment Officer and a Portfolio Manager of Royce & Associates, LLC, investment adviser for The Royce Funds. Mr. Royce's thoughts in this interview concerning the stock market are solely his own and, of course, there can be no assurance with regard to future market movements.

The original article is available here.


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