Royce's Co-Chief Investment Officer Whitney George has managed Royce Low-Priced Stock Fund since 2000. In this interview, Whitney talks about why the portfolio's positioning has remained mostly unchanged over the last few years and why he remains bullish on mining and energy stocks.
In light of Royce Low Priced Stock Fund's (RLP) recent underperformance versus the Russell 2000, how have you been responding?
While we have been actively looking for what we see as high-quality, low-priced stocks, the portfolio has been positioned in much the same way for the last four or five years. If you look at the sector and industry weightings from the end of March 2009 (close to the bottom on March 9, 2009) and compare them to those at the end of May 2012, you see that not much has changed. Our exposure to energy rose a bit, while our exposure to precious metals and mining companies fell slightly, but otherwise not a lot has changed. In addition, the portfolio still holds no banks or REITs.
We look stock by stock based on buying opportunities. This is the third straight year in which we have seen a double-digit dip in the spring for those industries and sectors that are highly cyclical and economically sensitive, which are the same areas that have been showing up in our screens as the most fundamentally attractive in terms of valuations. So while some of the individual names have changed, our search for the highest quality, most attractively priced and best-positioned companies has not.
What would you say to investors who might be concerned about the Fund's long-term prospects?
First, we feel very good about the portfolio, but we also understand why investors may be frustrated. We have significant investments of our own in the Fund, so we're feeling the pain along with everyone else. I think what's important for investors to know is that the discipline has not changed, the execution of the discipline has not changed, and the quality metrics of the portfolio right now look as good as ever in terms of balance sheets, returns on invested capital, and valuations. We think our first job is sticking to the discipline and our second is to be patient. We recognize that some of our holdings are out of favor, but as contrarians we see terrific long-term opportunities in these areas.
In which industries has the market's volatility been creating the most compelling opportunities?
As one can see from the Fund's short-term results, we've seen the best bargains in those cyclical, sensitive areas such as energy and precious metals. We have been very pleased with the buying opportunities. In many cases, we haven't seen the kind of values that we've seen recently since late 2008 or early 2009. We don't make large investments at any one time. We generally use dollar-cost-averaging and build positions slowly as their share prices come down and our confidence increases. Our process remains focused on individual businesses with high-quality characteristics selling at what we perceive to be attractively low prices.
What is the thesis for the Fund's positions in precious metals and mining companies?
The micro always comes first—it always comes before the macro when we look at companies. In our search for attractively priced stocks, we may find several in a single industry. That industry is likely being affected by economic events that are helping to drive stock prices lower. As contrarians, we look at these areas to find what we think are well-managed businesses with strong finances even as we try to determine what the market may be getting right or wrong about these companies. Why do we think a company's long-term prospects are better than what the market is factoring in at the moment?
The portfolio has for some time been positioned toward hard asset companies in the energy, materials and industrial areas. These areas represent an after-the-fact macro bet, which is that countries in the developed world will continue to debase their currencies as a way of dealing with the current global debt crisis. And when we have several holdings in a single industry, as we do currently with mining companies, macro events are going to have an effect. However, each company that we own in the portfolio was chosen on its own merits and not as part of a top-down bet on the prospects for its industry or sector.
More specifically with regard to our mining holdings, gold has corrected almost 20% four times in the last six years—in 2006, in 2008, in the fall of 2011, and just recently in 2012. During these corrections, gold has been a strong indicator of global liquidity—people tend to sell it only when they need to. So gold bottomed out during the Lehman Brothers crisis, it hit a bottom late last year when investors were highly concerned about the euro, and again this year when similar concerns were on investors' minds. And mining stocks have reacted disproportionately to those same liquidity issues that affect the price of gold.
During this current correction, we have added some new names and built our stakes in some old favorites, some of which are off their previous peaks by 60-70%. Many of these companies have high cap rates, strong returns on capital, and plenty of cash on their balance sheets—they screen very well by the metrics that mean the most to us when we look at a business. We first became interested in these companies a decade ago as they began to make the transition from speculative exploration businesses to industrial businesses producing a finite commodity that is often in high demand.
We are still confident that the market will recognize the strong fundamentals these companies possess. So while it's admittedly been a challenging ride over the last few years for the mining industry, we have seen historically that the resolution of these liquidity issues has meant good things for gold. Over the last seven or eight years, some of RLP's biggest successes were mining companies, so we're still bullish on the long-term prospects for the industry.
The situation with both precious metals and energy has me caught between my twin passions of history and math. With regard to gold, much of the fiscal policies that are in effect around the globe—particularly the widespread printing of money— indicate that the gold price should be climbing because historically that has been the case. However, the math has been stubbornly resisting history, though we see this as a temporary anomaly.
Are you equally confident in the portfolio's energy holdings?
With energy, I never thought that I would see a time when we would see oil at $100 a barrel while natural gas traded at $2 per MCF, yet here we are. We view this disparity as temporary in part because the globe's need for energy is too great for natural gas to remain this cheap. Our attraction, however, is more tied to companies with pristine balance sheets and strong operations trading at very attractive multiples. As we have always done with energy companies, we're concentrating on equipment and services companies.
Important Disclosure Information
This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Royce Low-Priced Stock Fund invests primarily in small-cap and micro-cap stocks, which may involve considerably more risk than investing in larger-cap stocks (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund may invest up to 35% of its net assets in foreign securities, which may involve political, economic, currency and other risks not encountered in U.S. investments. (Please see "Investing in Foreign Securities" in the prospectus.)
Whitney George is Co-Chief Investment Officer, Portfolio Manager, and Managing Director of Royce & Associates, LLC, investment adviser to The Royce Funds. Mr. George's thoughts in this piece are solely his own and, of course, there can be no assurance with regard to future market movements.
Distributor: Royce Fund Services, Inc.