Can you describe Royce’s approach to risk management?
At Royce, we have a distinctive approach to risk management that encompasses three different areas. First of all, as small-cap equity specialists, we believe risk management is critical in our space because of the reduced liquidity and higher volatility, we really do take risk management very seriously as small-cap managers. Secondly, we are active managers, so we are in the business of taking risk. The goal of our risk management program is not to mitigate risk, we’re not just trying to eliminate risk from the portfolios; we’re trying to take prudent risk. We’re trying to get the most optimal risk/return tradeoff for the stocks that we pick in our portfolios. And finally, we believe that risk management has to be integrated into the process. Our portfolio managers consider themselves risk managers first. They're the first line of defense.
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How does the independent risk review process work?
Our independent risk reviews are conducted twice a year for each of our strategies. The way we approach risk management is collaborative. We really felt like we wanted to have a risk management process that was integrated, that was embedded in with the investment teams, with the investment process. But we also really see value in having an independent review where we’re able to look at the portfolios separately using distinct processes, using different methodologies, and then we come back and collaborate with the PMs, where we’re sharing our thoughtful analysis on the portfolio. And we’re challenging our portfolio managers to consider how we’re looking at it, but we’re also doing it in a collaborative way where we’re discussing these things together.
Do the risk reviews ever reveal unintended consequences?
One of the key insights we hope to gain when we run our risk reviews for each of our strategies is trying to ensure that there were no unintended consequences of the portfolio stock selection or portfolio construction process. You could imagine a portfolio manager is considering a multitude of factors when they're building a portfolio. And some of those factors, when overlaid on each other, can cause these unintended risk concentrations, so we use multifactor models so that we really understand the underlying risks that have been taken in the portfolio, and sometimes we do see that compounding effect, and it's great to be able to point it out to a portfolio manager.
What are some examples?
One example would be a portfolio manager who was trying to implement a theme, and although the theme was diversified across sectors, the implementation of the theme resulted in some risk concentrations in an industry that was beyond the level the portfolio manager was comfortable with, and we were able to point that out through our factor analysis, and the portfolio manager decided to pare back on some of that risk, thereby improving the risk/reward profile of the portfolio.
Another example of some of the things you might uncover through these risk reviews is a particular portfolio manager had some concerns that some very small positions in his portfolio were not adding any value. They were small positions; he had difficulty building them up due to the liquidity in those positions, but he felt that they weren't adding value. We did a performance attribution by position size, we found that although they didn't contribute to performance, they were significantly reducing the risk of the portfolio and overall improving that risk/reward tradeoff. So we were able to give that feedback to the PM and he continued to maintain those position sizes.
Important Disclosure Information
The thoughts and opinions expressed in the video are solely those of the persons speaking as of October 15, 2018 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. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.)
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