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Royce Funds Commentary - Getting Rightsized with Small-Caps

March 07, 2014 | About:
Holly LaFon

Holly LaFon

248 followers

By Gunjan Banati

Our more than four decades of asset management experience have taught us that the small-cap asset class is a much larger and broader universe than a single index can encompass.

Watch the video here.

"At Royce, when we consider the small-cap universe, we have always taken a comprehensive approach starting with the micro-cap segment of the market.

We've been investing in micro-cap stocks since the early '70s and our investment process has benefited enormously from looking at companies early and following them closely through their life cycles as businesses."

"One of the core premises in small-cap investing, regardless of the individual market cap, is the idea that looking where others don't offers distinct advantages.

With small-cap now an established asset class, the companies trading closest to the periphery have become somewhat orphaned, and there lies the opportunity."

"By extending into the smid-cap segment we not only allow our portfolios access to a larger investment universe that encompasses an underappreciated zone of the equity market, but we also enable our best investments to continue to benefit our clients even as they move up the market-cap spectrum.

The most frequently used definition for smid-cap stocks is membership of the Russell 2500 Index. This index includes all the stocks within the Russell 2000—that's the index most frequently used to define small-cap stocks—plus the 500 smallest-cap stocks from the Russell Midcap Index. So, basically, the smid-cap universe of stocks is all small-cap stocks plus smaller mid-cap stocks."

"Examining performance characteristics over time can give us a clear case for the opportunity offered in the smid-cap space.

This chart compares the full spectrum of small-cap—the Russell 2500 Index, the Russell 2000, and the Russell Microcap Index—and it compares that to the large-cap universe, which is represented by the Russell 1000 and the Russell 200 Index."

"To allow for complete participation of all the indices, we selected a start date of June 2000—that's the inception of the Russell Microcap Index—and we looked at all monthly rolling five-year returns and five-year standard deviations.

As one would expect, micro-cap, small-cap, and smid-cap—all those stocks offered higher returns with higher volatility when we compared them to their larger-cap counterparts."

"Notably, the Russell 2500 Index offers the highest average five-year annualized return of all five indices at 7.26%, and it does so with lower volatility than the small-cap and micro-cap indices. The average five-year standard deviation for the Russell 2500 was 19.21%.

When we think of the smid-cap universe, it combines many of the attractive performance attributes of the small-cap segment with some of the liquidity and business stability characteristics that are more traditionally associated with larger businesses."

"As you can see, the aggregate performance of the micro-cap companies lagged the small and smid companies while taking on additional risk. The micro-cap index covers the very smallest investible companies of the U.S. equity market and it zeroes in on what we believe is the most inefficient part of the stock market that's ideally suited for active managers.

Our approach to the micro-cap category centers on companies that have strong balance sheets and high returns on invested capital, which we also believe appropriately addresses the volatile behavior of the asset class."

"Our more than four decades of asset management experience have taught us that the small-cap asset class is larger and a broader universe than a single index can encompass. The acceptance of small-cap stocks as a permanent part of an investor's portfolio, combined with the traditionally dominant allocation to large-cap stocks, has created a meaningful investment opportunity in those stocks that fall both below and above the conventional small-cap boundaries."

Read the original article here.

Important Disclosure Information

The thoughts and opinions in the 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 currentprospectus. 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). Standard deviation is a statistical measure within which a fund's total returns have varied over time. The greater the standard deviation, the greater a fund's volatility. Please read the prospectus for a more complete discussion on risk. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. The Russell 2000 is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 index. The Russell 2500 Index is an index of the 2,500 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell Microcap Index includes 1,000 of the smallest securities in the small-cap Russell 2000 Index, along with the next smallest eligible securities as determined by Russell. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. he Russell Top 200 Index measures the performance of the largest cap segment of the U.S. equity universe and includes approximately 200 of the largest securities based on a combination of market cap and current index membership. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.


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