How Royce Is Adapting to a Volatile Environment—Royce
article , video 03-22-2022

How Royce Is Adapting to a Volatile Environment

Senior Investment Strategist Steve Lipper details how small-cap styles are being affected by the current environment and how Royce is navigating these shifts.

TELL US
WHAT YOU
THINK

How is the current macro environment affecting small-cap styles?

We think the current environment is going to continue to be tailwind for small value and headwind for small growth. Let’s break it down to a couple of things. The first is around valuation, the second is around cyclicality, and the third is probably about inflation. With regard to valuation and the benefit of liquidity, as the Federal Reserve goes from quantitative easing to quantitative tightening, those stocks that benefited most from abundant liquidity, are going to continue to get hit the hardest. We think that those are largely small growth stocks. If we also go to valuation and expect that overall we’re going to see valuation compression across small caps, that again is going to hit the higher valuation, which hit small growth stocks harder. But then, let’s think about cyclicality. Again, we think that you want to have exposure to economic cyclicality. And the cyclical beneficiaries are more in small value than they are in small growth.

Russell 2000 Value vs. Russell 2000 Growth Top Three Overweights By Industry Group
As of 12/31/21

Banks, real estate, and utilities

And finally, around inflation—actually, you have a number of business models in small value that are inflation beneficiaries: banks would be one, materials would be another. But there are others as well. If you contrast that with small growth, that will tend to be more populated by, often, money-losing healthcare stocks, as well as technology and software stocks. So those won’t give you the cyclical exposure, or as much. They’re going to have valuation compression, and to the extent you have lower liquidity, we think the market is going to be less hospitable there. So we think the environment continues to be one of tailwind for small value and headwind for small growth.

Russell 2000 Growth vs. Russell 2000 Value Top Three Overweights By Industry Group
As of 12/31/21

Software & services, pharmaceuticals, biotechnology & life sciences, and health care equipment & supplies

How have Royce’s value strategies been adapting to this environment?

There are two things to recall about Royce’s value strategies: first of all, that they are varied, that they execute different parts of the market. Secondly, there is some commonality. Many of them will have meaningful representations in both Information Technology as well as in Industrials.

However, there are two particular business models which we have large, now, and more recently increasing weighting in. The first of those is banks. And we may have the highest representation in banks than we’ve had, perhaps ever. We think the bank business model intersects particularly well with where we are in the economic cycle. A couple of reasons for that. One is rising interest rates are to the benefit of banks, because banks earn a spread between their deposits and their loan rates. The second is that with inflation, is often because of economic growth and you see loan growth. So if you see faster loan growth at banks and widening interest margin, that’s a really wonderful environment.

The other business model that we find very interesting are distributors—whether that’s industrial distributors or technology component distributors. And the intersection of the distribution business model and inflation is actually very beneficial. Because if prices are rising, then distributors who often work on very small margins can get a little bit of a bump across a wide range of sales volume, and that tends to increase their profitability very meaningfully.

So we would say that the areas where we’re high and have increased our focus on are banks and industrial distributors across the value strategies. And we feel very good about their opportunities ahead.

VIEW FUND PERFORMANCE

 

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the persons speaking as of February 8, 2022 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.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

Sector weightings are determined using the Global Industry Classification Standard ("GICS"). GICS was developed by, and is the exclusive property of, Standard & Poor's Financial Services LLC ("S&P") and MSCI Inc. ("MSCI"). GICS is the trademark of S&P and MSCI. "Global Industry Classification Standard (GICS)" and "GICS Direct" are service marks of S&P and MSCI.

Cyclical and Defensive are defined as follows: Cyclical: Communication Services, Consumer Discretionary, Energy, Financials, Industrials, Information Technology, and Materials. Defensive: Consumer Staples, Health Care, Real Estate, Utilities.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. All indexes referenced are unmanaged and capitalization weighted. The Russell 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.)

Share:

Subscribe:

Sign Up

Follow: