How did you become a portfolio manager who specializes in high-quality, ‘premier’ small-caps?

Reading about how industry structures, different strategies, and capital allocation decisions by two companies in the same business could lead to very different results was what initially drew me to investing in stocks. I’ve been incredibly fortunate throughout my career to work for a series of great investors who successfully employed Warren Buffett’s “think like a business owner” and “buy great businesses at fair prices” approach to investing while adding their own insights and enhancements to the process. So, it was a natural fit when Chuck Royce was seeking someone to work with him on Royce Premier Fund. For me, Royce had always been the mecca of small-cap investing, and my 21 years at the firm have not disappointed. The opportunity to work with and learn from Chuck while also trading thoughts with and drawing on the perspectives of Royce’s deep bench of seasoned investment professionals has been invaluable.

What are the primary attributes you look for in our Small-Cap Premier Quality Strategy?

Steven McBoyle, Andrew Palen, and I take a business buyer’s approach to identify quality small-cap companies for Premier. We want to buy companies that generate high returns on invested capital that we believe have durable business models and reinvestment opportunities that will enable them to compound shareholder value at high rates of return over the long run. Key financial indicators of quality include high returns on invested capital (well above their cost of capital), low financial leverage, and consistent free cash flow generation. These outputs are typically a function of a company that has a sustainable competitive advantage such as high switching costs, a favorable market structure, or discernible value propositions that are difficult to replicate. Such businesses often have attractive characteristics such as recurring revenue and leading market positions. Finally, we like companies whose stocks are selling at valuations that we believe do not fully reflect their business prospects. The strategy’s long-term holding period enables us to arbitrage time, taking advantage when a quality company’s stock is depressed for cyclical reasons or temporary, company-specific issues that we believe are fixable.

How do you go about screening or otherwise finding companies with these qualities?

Screening is one of many idea generation tools we use. Our core screens consist of scanning the small-cap universe for key metrics such as return on invested capital, low leverage, and free cash flow conversion and reinvestment rates. We read industry publications and interview independent experts on the company or industry of focus. Having been small-cap specialists for more than 50 years, we’ve developed a deep and broad institutional knowledge that allows us to observe changing dynamics in a range of industries and companies over time. We also engage deeply with company management teams via in-house or virtual meetings and at conferences. In addition, we periodically review companies we’ve held in the past. These activities and institutional knowledge give us a sizable cohort of companies for potential inclusion in the portfolio.

Can you discuss a few holdings in which you have high long-term confidence?

Stella-Jones is an interesting holding. It’s a Canada-based provider of treated wood infrastructure products, with 70% of its sales in the U.S. (from U.S.-based facilities). It holds leading market shares in wood utility poles (47% of sales) and railway ties (25% of sales), both of which are oligopoly industry structures. In addition to predictable sales from multi-year contracts with major customers to support the annual replacement of poles and rail ties, infrastructure spending should lift long-term growth as utilities invest to harden and expand their electricity grids in the face of rising demand. Stella-Jones recently expanded its addressable market by $5 billion with the purchase of a leading producer of steel high-voltage electric transmission lattice towers and poles. The Fund took advantage of the stock’s underperformance in 2024 to build our position.

We think the long-term growth and cash flow power for many of our holdings is further bolstered by favorable secular growth trends that should outlast the depressive impact on demand of a more punitive global tariff regime. Here are two examples: Arcosa generates most of its profits from the sale of aggregates from its quarries (sand, gravel, and crushed stone which are the essential foundation for roads, bridges, and buildings) and the manufacture of utility structures and metal poles used in energy generation, distribution, and substation applications. Arcosa’s aggregates business is positioned to benefit from continued spending to upgrade U.S. infrastructure, net population growth in most of the states it serves, reshoring-driven construction and pricing power from the local nature of the business, and industry consolidation. The engineered structures business is seeing solid long-term order growth and healthy backlogs driven by utilities’ investments to harden their aging grids, integrate renewable energy sources, and increase capacity to meet rising load growth due to drivers such as the electrification of transportation and AI data center demand.

JBT Marel is among the largest providers of food and beverage processing equipment in the world. In business for more than 100 years, the company has consistently competed and won on technology, not price. The company is currently seeing some near-term customer hesitancy about placing large equipment orders until there is greater certainty around tariffs. However, about half of the company’s revenue is recurring in the form of parts and services sold into its large installed base of systems, which provides cash flow consistency even when new equipment spending is tepid. Secular drivers of equipment spending include rising global protein consumption, food safety, and investment in automation that yields a high return for customers via reduced labor and faster throughput. John Bean’s global footprint reflects “local for local” manufacturing and services, reducing the magnitude of its direct tariff exposure. The recent acquisition of Marel offers significant “self-help” opportunities in the form of cost synergies to be realized.

What is your current outlook for the Strategy given how volatile and uncertain the markets have been so far in 2025?

We’re really pleased that Premier again provided downside protection in the recent sharp small-cap bear market. The Fund’s historically attractive downside capture is a function of our disciplined focus on owning quality companies with high returns on invested capital, cash generative business models, and low financial leverage. While our holdings are not immune to macroeconomic changes, the strength and sustainability of their underlying competitive advantages ultimately determine their ability to grow shareholder value at attractive rates over the long run. Scale advantages, strong brand reputation, and differentiated offerings that customers seek out or design into their end products are just a few of the value drivers that allow our companies to not only weather challenging periods but also often emerge even stronger, having taken market share or acquired weaker competitors. The long-term investment horizon inherent in how we manage the Fund means that we have owned many holdings through previous tumultuous economic or industry cycles, so we’ve seen the resiliency of their business models. Our conviction in this durability, combined with the recent contraction in stock prices, underscores our view that the Fund continues to offer a favorable long-term risk/ reward profile.

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