In a market environment that has favored high-yield investments more than it has companies with strong underlying fundamentals, risk-oriented approaches such as ours have languished. Portfolio Manager Jen Taylor talks about how we try to mitigate risk when investing in micro-caps and how, despite the current market, we stick to our discipline.
“I think the Royce advantage in micro-caps really has a lot to do with focus and a lot to do with so much history in looking at this category, particularly through so many cycles,” says Jenifer Taylor, manager of Royce Micro-Cap Fund and Royce Capital Fund – Micro-Cap Portfolio and assistant manager of Royce International Micro-Cap Fund and Royce Micro-Cap Trust, a closed-end fund.
At Royce, we began to take notice of the micro-cap segment in the early ‘90s, not long before the small-cap sector began gaining more institutional acceptance and the universe’s cap size started to expand. During this time, we also observed that the small-cap market was bifurcating into two distinct sectors based on capitalization: the upper tier of small-cap, which today encompasses companies with market caps between $750 million and $2.5 billion; and the lower tier, which includes companies with market caps up to $750 million that we refer to today as micro-cap.
Considered today as a professional asset class, though still underfollowed in our opinion, small-caps benefit from a higher level of institutional focus. In contrast, micro-caps more closely resemble the small-cap space before its acceptance as a professional asset class: a volatile, inefficiently priced, not always researched sub-set often underappreciated and misunderstood.
As risk managers, the characteristics of the micro-cap asset class were highly attractive to us. While less liquid and faced with more trading difficulties than small-caps, we believed that micro-caps offered greater return potential and were best suited for long-term investors like us. Taking into consideration the inherent risks of this evergreen sector, we began developing a broad diversification strategy—still in practice today—that we believed would appropriately address the asset class’s volatile behavior.
Our approach to the micro-cap category centers on companies that have strong balance sheets and high returns on invested capital. In an environment starved for growth, investors’ preference for high-yielding equities has put investment approaches such as ours out of sync.
“We want to make sure that they’re in a position to survive unexpected downturns or mishaps,” says Jen. “What has gone underappreciated and what has yet to be discovered I think in our asset class is the real strong underlying business,” she adds.
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Important Disclosure Information
The thoughts expressed in this video are solely those of the person speaking and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.
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. Micro-cap, small-cap, and mid-cap stocks may involve considerably more risk than investing in larger-cap stocks (please see "Primary Risks for Fund Investors" in the prospectus).