History | Royce

1970s

Reeling from the aftermath of losses during the 1973-4 “Nifty Fifty” market, Chuck Royce begins to formulate his pioneering risk-conscious approach to buying small-cap stocks based on two critical insights.

Chuck Royce began his career on Wall Street as an equity analyst in the 1960s. Although he had studied with value investing guru David Dodd at Columbia Business School, Royce did not initially see himself as a value investor—or even one primarily concerned with risk. Like many ultimately successful investors, it took the painful experience of losing money to help him shape his investment outlook—which became the valuation-sensitive approach the firm has evolved and refined since our founding in 1972.

The stock market of the early to mid-70s was considerably volatile, accompanied by a level of economic uncertainty unseen since the Great Depression. Between 1969 and 1972, small-cap stocks declined and helped to lead many investors to what were considered safer, more stable investments in the form of larger, higher-profile names on the theory that they were both less risky and more likely to be profitable. This became known as the “Nifty Fifty” market, in which investors looked to a group of large, mostly multinational firms as the safest and surest route to growth.

Small-cap specialists since 1972
Small-cap specialists since 1972.

However, by the end of 1974, a little more than two years after Chuck had assumed full portfolio management responsibilities for what is now Royce Pennsylvania Mutual Fund, the "Nifty Fifty" had collapsed, beginning a slow, seemingly inexorable slide in 1973.

Letter from Chuck Royce announcing his management of Pennsylvania Mutual Fund
Letter from Chuck Royce announcing his management of Pennsylvania Mutual Fund

Interestingly, Chuck’s early focus in the portfolio was not on small-caps or quality and valuation metrics. He only began to formulate what became the central tenets of his investment philosophy in 1973-4—as a direct response to dismal results and mounting losses in the portfolio wrought by the fall of the “Nifty Fifty” market and the widespread bear market that came with it. His portfolio fell 48.5% in 1973 and 46.0% in ’74. Chuck later told financial journalist Jason Zweig, “For me, it was like the Great Depression. Everything we owned went down. It seemed as if the world was coming to an end.”

These losses inspired two insights that were critical for developing his highly disciplined, bottom-up approach. First was the idea that long-term investment success was the product of both preserving capital and growing it. An approach that lost less during downturns while remaining competitive in more bullish periods could provide strong absolute returns while also being likely to beat its benchmark, in particular over periods of three years or more. The second key idea was that this risk-conscious approach could not only be highly effective in the small-cap asset class but could work even better there than in more established (that is, larger) asset classes because of small-cap’s inefficiency and related lack of institutional attention.

Most other investment professionals simply did not think that conservatively capitalized, financially strong businesses with steady earnings and positive free cash flows could be found in the small-cap space. In bucking this consensus view, Chuck was among a small handful of pioneering portfolio managers who were willing to invest in what were then called small- and medium-sized companies. The same misperceptions that led most other portfolio managers to avoid small-cap stocks were those that Chuck recognized could potentially work to his portfolio’s advantage. Investing in companies that were unknown or barely researched allowed him to uncover numerous potentially profitable opportunities.


1980s

The stock market rode waves of volatility through the eventful 1980s. Chuck fine-tuned the firm's signature disciplined approach and continued to post impressive absolute and relative performance while the launch of the Russell 2000 Index acted as a catalyst for growing institutional interest in small-caps.

Chuck continued to fine-tune the firm’s signature disciplined approach in this very eventful decade, which began with a record high prime rate of 20% and included the U.S.’s worst recession in 40 years. The stock market recovered its balance following the recession, helping small-caps lead the market from 1974 through 1983—a 10-year stretch that remains the longest consecutive period of outperformance for the asset class relative to large-cap stocks. (Source: Stocks, Bills, Bonds, and Inflation 1997 Yearbook, Ibbotson Associates.)

Larger companies resumed market leadership through the mid to late '80s, while Chuck and our growing staff continued to find inefficiently priced small companies. Tom Ebright joined the firm in 1978, assisting Chuck in managing the firm’s assets and playing a vital role in spreading the word about our approach and its success.

Tom Ebright and Chuck Royce
Tom Ebright and Chuck Royce

Despite strong absolute and relative results for Chuck and other active management pioneers throughout much of the ‘80s, institutional recognition of small-cap as an established asset class was slow to come. This began to change, however, when the Russell 2000 Index was introduced in January 1984 (back-tested performance was calculated from 1979). Now the best known and most widely used small-cap index, the Russell 2000 acted as a catalyst in the ‘80s for growing institutional interest in small-caps.

Nonetheless, perceptions change slowly, and by the end of the decade active small-cap strategies such as ours were still seen by many as outliers, despite nearly a decade’s worth of success.

1990s

Small-caps grew in both cap size and popularity during the 1990s, leading us to view the asset class as split into two distinct sectors based on capitalization—small-cap and micro-cap. As critical as these changes were to the firm and how we structure our portfolios, equally significant were the additions we made to our investment staff and to our product line during this decade.

The decade proved to be full of critical developments for both small-caps and our firm. The '90s saw dynamic performance for smaller companies, causing the sector to grow more popular, and the parameters of what constitutes small-cap expanded by the middle of the decade to include companies with market capitalizations up to $1 billion.

Chuck Royce on Financial Advisor Magazine
Chuck Royce on the cover of Fee Advisor, 1995

The increase in both cap size and popularity meant that small-cap stocks evolved; they were no longer quite as small, unknown, or under-owned. As of December 31, 1999, the weighted average market capitalization of the small-cap Russell 2000 Index was $1,360 million, compared to $140 million as of June 30, 1985.

Small-caps also gained increasing recognition as a professional asset class, with much of the growth in mutual fund offerings occurring between 1992 and 1997. Morningstar listed only 20 small-cap funds in existence as of December 31, 1982. This compared to 98 funds as of December 31, 1992 and 301 as of December 31, 1999. (The Morningstar universe of small-cap funds includes only the oldest share classes of funds that fall under the Morningstar Category of Small Blend, Small Growth, or Small Value.)

The asset class underwent other related changes. Early in the decade, we began to observe that the small-cap market was bifurcating into two distinct sectors based on capitalization: small-cap and micro-cap. What we learned from these observations had a lasting effect on the way that we structured our portfolios going forward. (And the contours of this shift remain in place, even as the market cap ceilings have risen over the last 20+ years.)

Micro-cap stocks (which we currently define as those with market caps up to $1 billion) offer many choices but also have limited trading volumes, higher volatility, less liquidity, and little, if any, research coverage. We therefore choose to broadly diversify our portfolios that invest in micro-cap companies.

Small-caps (which we currently define as those companies with market caps from $1 billion to $3 billion) is more efficient, offering greater trading volumes, narrower bid/ask spreads, greater liquidity and generally more widespread analyst coverage. In this, they resemble the bigger mid- and large-cap siblings. We thus felt comfortable limiting the number of positions in our small-cap strategies, typically holding less than 80 companies, which continues to this day.

This recognition of the distinction between small and micro-caps led us to introduce the more concentrated Royce Premier Fund and the widely diversified Royce Micro-Cap Fund in 1991. Royce Micro-Cap Trust, also widely diversified and the only closed-end fund focusing on micro-cap securities, followed in 1993.

Royce Micro-Cap Trust launch
Chuck Royce with The Royce Funds team at the listing of Royce Micro-Cap Trust on the NYSE

That same year saw also the debut of Royce Total Return Fund, our first mutual fund that focused on dividend-paying small- and micro-cap companies (we ran a similar portfolio for an institutional client that launched in 1979). Dividends were another area in which Chuck was a pioneer. Many still thought of “dividend-paying small-cap company” as an oxymoron, if they thought about it at all. However, our own research and investment experience showed that dividend-paying small-caps outpaced non-dividend-payers—and did so with lower volatility. In 1996, we expanded into the life insurance market with the introduction of two annuity portfolios—a small-cap contrarian value and a micro-cap multi-discipline strategy.

The Team in the early 1990s
Our team of analysts in the early 1990s

As critical as these changes were to the firm, equally significant were the additions to our investment staff. Two particularly key hires came early in 1998, when Chuck brought on two portfolio managers he had known as respected competitors for many years—Buzz Zaino and Charlie Dreifus. The two small-cap specialists had each developed his own unique investment approach, so their addition to the firm, along with the other new investment professionals hired during the decade, gave us the largest and strongest investment team ever up to that point in our history as well as a more expansive number of small-cap strategies.


2000s

The start of the new century proved to be a very successful period for many active small-cap value approaches, as well as an important time for the firm as we built our investment teams, grew assets, and expanded our reach into both international investments and distribution.

The decade began with challenges for small-cap stocks, particularly for small-cap value, which throughout the Internet stock boom languished to the point where many Wall Street observers wondered if the style would ever be effective again. This changed radically in the years following the Internet bubble, and small-cap value enjoyed very strong results through most of the decade, which would also be marked by the horrific events of 9/11, a real estate crash, and the ensuing Global Financial Crisis.

This period saw the fastest asset growth for the firm in our history as strong results and wider distribution reach—the latter the result of Royce joining Legg Mason in the fall of 2001—spurred the expansion. We were pleased with the success and gradual recognition that we and others involved in active small-cap management were enjoying.

Other changes were equally significant. The emergence of distinctive performance patterns for small- and micro-cap stocks that began in the ‘90s continued to play a key role in the way that small-caps behaved and in the way that we constructed portfolios and thought about the asset class as a whole. Equally important, we continued to widen our distribution reach, sub-advising two UCITs portfolios for Legg Mason.

Another major development was our expanded reach as we began to devote more time and resources to non-U.S. companies. The vast number of opportunities in small-cap companies across the globe began to present substantial opportunities to find quality businesses at attractive valuations.

Finally, we saw more growth in our investment team. Younger investment professionals, including Bill Hench and George Necakov, moved from analyst roles to portfolio management while experienced PMs joined the firm, including Jay Kaplan, Lauren Romeo, Steven McBoyle, and Mark Rayner. Each has made important contributions to the growth of the firm and the evolution of our distinctive investment approaches.

Soon after the decade began, risk-conscious active small-cap approaches were rewarded as the Internet Bubble burst, unleashing a multi-year run of success for small-cap value. It ended with many of these same strategies holding their value relatively well during the Financial Crisis.


2010s

We remained steadfast with our investment disciplines, while at the same time intentionally evolving our business platform and offerings. All of this allowed us to enter the new decade well positioned as Royce Investment Partners with an unchanged goal—to deliver a great small-cap investment experience to each of our clients across all of our vehicles and strategies.

Recovery from the Financial Crisis proceeded slowly and fitfully, though in March 2009 stocks began a long, and at first volatile, rebound. Government policies designed to set the stage for recovery—particularly zero interest rates and quantitative easing—had significant unintended consequences.

This was especially true from 2011-2015, when QE (quantitative easing) and zero (or near zero) interest rate policies inflated many asset values while also fostering a barbell-shaped range of small-cap returns, with bouts of leadership from defensive, typically high-yield stocks at one extreme and fast-growing healthcare and/or tech issues at the other. The growing popularity of passive investing and ETFs also created challenges for active, disciplined, bottom-up, and risk-conscious investors like ourselves.

During these years, patience was critical. It is easy to talk about the importance of patience and discipline when markets are solid and portfolios are doing well. Yet at some point these things will change—and both will be tested, as they have been in this decade, the most challenging in our long history.

We made progress in this period to better position our small-cap offerings, efforts that included streamlining the number of our investment strategies and launching collective investment trusts, separately managed accounts, and new international distribution agreements.

In part as a response to these changes, and in larger part to better describe the breadth of our business and the importance we’ve always placed on the spirit of partnership, we announced a new brand name for the firm—Royce Investment Partners—in December 2019. Our firm has grown in many significant ways over the years, from the depth and capabilities of our employees, to our client base, our investment offerings and vehicles, and, importantly, our corporate structure. The goal in evolving our brand identity was to better represent to all of our constituents who we are now as a firm.

royce-investment-partners
On December 16, 2019 we rebranded as Royce Investment Partners


Looking Ahead

Looking ahead to the 2020s, we think investors should be mindful that environments which feature increased uncertainty, turbulence, and market volatility often provide opportunities for companies with leading market positions and strong balance sheets to solidify or expand market share. Volatile environments have also been historically favorable for active small-cap managers.

As the decade winds down, we see four favorable factors in the market environment—low inflation, modest valuations, moderate growth, and ample access to capital—that we think support solid-to-strong small-cap performance in the intermediate term regardless of current anxieties. These four factors paint an attractive picture in our view, one that small-cap investors might be at risk of missing if they pay more attention to the macro picture than to company fundamentals, where we think the real action is.

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