Royce Funds Commentary - 'There's No Such Thing as a Sure Thing'
There was extraordinary excitement surrounding this year's Kentucky Derby. This anticipation was well rewarded by a dramatic and electrifying contest. The favorite, California Chrome, took the lead roughly halfway through the race and never looked back, winning by almost two lengths.
The same horse's victory in the Preakness Stakes two weeks later was, if anything, even more decisive. This set up the tantalizing possibility of a Triple Crown winner, the first since Affirmed took the prize more than 35 years ago in 1978. (At the time we managed but a single mutual fund.)
Indeed, as the date of the Belmont Stakes crept closer, more and more people began to talk as if the coveted and rarely won Triple Crown was in the bag. California Chrome's dominance seemed to increase with each win.
His ability to pick up speed as the race progressed was commonly cited as the likely key to victory because the Belmont boasts the longest track of the three legs that constitute the Triple Crown.
Then a funny thing happened. California Chrome, the "sure thing," ran a solid race but failed to secure victory, finishing fourth. The winning horse, Tonalist, had not run in either the Derby or the Preakness, making him a dark horse in at least the figural sense.
The wake of the upset led us to reexamine the vagaries of performance-based contests. Thinking through the implications of what occurred, we made a rough count of the numerous times when other sure things had failed to achieve the ultimate prize and an upset winner was crowned instead.
Interestingly, this happens quite often and occurs in numerous endeavors, including sports, popular culture, the arts, and even asset management.
More important, it gave us an opportunity to reflect on our own experiences investing in small-cap stocks and managing mutual funds.
There have been times during our 40+ years of history when value-rooted small-cap approaches have been the barely acknowledged underdog as well as the prohibitive favorite. There have also been long stretches where our methodology and our asset class were thought of, if we were thought of at all, as being among the middle of the pack.
In this business, every asset manager must live with the reality of the scorecard. Here at Royce we measure our performance against appropriate benchmarks, competitors, and—most crucially—our own absolute standard. We take these measurements over market-cycle and other long-term periods.
We make strenuous efforts to learn from our mistakes in several dimensions—at the most critical level individual stocks, of course, but also in terms of sector and industry weightings, country exposure, risk tolerance, and overall portfolio performance.
We are also aware that there are influential sources that rate, grade, and rank both fund and portfolio management records.
Indeed, the various methods of evaluating portfolio performance, and the sheer number of people willing to do that for us, make our own internal standards that much more significant.
When buying stocks, we attempt to tune out the Wall Street noise and come to our own independent conclusions regarding the companies we are considering for inclusion in our portfolios.
We attempt to do the same when it comes to evaluating portfolio performance. That is, we focus on the job that we need to do successfully to help our shareholders (and ourselves, since we are among the largest individual shareholders in the Funds we manage) build wealth over the long run.
As Chuck Royce (Trades, Portfolio) has often said, you can only eat from the table of absolute performance.
Sometimes approaches like ours are considered in vogue, other times out of favor, and still other times somewhere in between.
Our task is to run the best race we can, always trying to improve, and focus on what is important. And as we think about it, that's how we started out, not long before another horse, Secretariat, broke records and won the Triple Crown in 1973.
Important Disclosure Information
The thoughts and opinions expressed in the piece are solely those of Royce & Associates, LLC, investment adviser to The Royce Funds. There can be no assurance that Royce will be successful in attaining its investment goals, and there is 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. Investments in securities of small-cap stocks may involve considerably more risk than investments in securities of larger-cap companies. (Please see "Primary Risks for Fund Investors" in the prospectus.)