article , video 11-11-2014

Think About Active Management in Small-Caps

An active management approach can be particularly useful when trying to identify self-financing companies that have the ability to stand up to challenging market environments, including those less driven by central bank interventions. 

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Francis Gannon on Legg Mason

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"Investors should be paying closer attention to the important role of active management, especially in the small-cap asset class. From our standpoint, there is a clear qualitative difference between active strategies today and that of the more passive indices.

"For example: In looking at the Russell 2000, if you were looking at that index today, you see an index in which 25% of the names in the index are actually non-earners,1 and of that 25%, over 40% comes from the healthcare industry, specifically biotechnology companies, which have been a great boost to performance over the past several years, which, in our opinion, has actually skewed risk.

"If you were to look at the non-earners in portion of the overall index today, you would see an area of the market that has done quite well over the past several years, but it has also skewed valuations. From our standpoint, as a risk manager in the small-cap asset class, we think there is much greater opportunity in some of the higher-quality areas of small-cap that the market is not truly focusing on right now.

"Quality, to us, is a company within the small-cap space that doesn't need access to the capital market; that is not over-levered. Many small-cap companies need access to the capital markets and are over-levered. We tend to focus on companies that are under-levered, the very old kind of Graham and Dodd idea of companies that own more than they owe. Our definition of quality really stems from the fact that we want to invest in very good companies; high-quality companies that are selling at a very significant discount to what we believe their intrinsic net value is.

"Everybody knows in small-caps that there are two things that small-caps tend to be known for: Number one is the fact that they have done well historically over long periods of time. But there has also been much greater volatility."

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the person speaking 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 current prospectus. Please read the prospectus carefully before investing or sending money. The Royce Funds invest primarily in securities of micro-cap, small-cap, and/or mid-cap companies, which may involve considerably more risk than investing in securities of larger-cap companies. (Please see "Primary Risks for Fund Investors" in the prospectus.) Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. The Russell 2000 Index is an unmanaged, capitalization-weighted 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 performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

1 Source: Furey Research Partners

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