article 04-17-2017

Welling on Wall St: Small Cap Value's Turn

Portfolio Manager Chuck Royce and Co-CIO Francis Gannon sat down with Kate Welling of Welling on Wall St. for an exclusive interview on where small-cap value is headed.

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Portfolio Manager Chuck Royce and Co-CIO Francis Gannon sat down with Kate Welling of Welling on Wall St. for an exclusive interview, discussing important events in the asset class and what's next for small-cap value.

Chuck said, "There was a shift, starting in the middle of last year, when the correction ended, from growth leadership, which had been straight up for six years, to value. And this is the most important thing for us."

Frank added, "What's critical here is that we think people are missing [this] important shift in the small-cap market. And I've always been a believer that what works in a market going into a peak is not going to work coming out of the subsequent decline.”

Frank believes we are in the midst of a consolidating market, "What the market is doing in our space, we think, is consolidating right now. There are two types of corrections – price and time. And we are in a consolidating moment for the Russell, in time. The Russell peaked in December and it hit a couple of highs here – one in February and one in March. Leadership is rotating though sectors, which is something quite healthy for the market to go through. And the surprise is that earnings could do better than people are anticipating."

He also comments on value's prospects: "We think value will continue outperforming by a dramatic margin. Because now the rotation is away from defensives – bond proxies – to cyclicality – economically sensitive stocks – where research and having an institutional knowledge base within the sector actually can payoff, from an active management standpoint.

Chuck remarked on the cyclical rebound, and why active managers should do best in a more normalized market: "Normal rates, I think, create normal equity environments, especially for stock pickers. We're already seeing that happen. That's setting up a good environment for active management. For risk managers, as all active managers consider themselves to be. That's the element we're able to overlay, in looking at a stock, we'll look at the risk."

On where he's finding innovation and interesting opportunities, Chuck said, "We think the industrial space presents us with a good intersection of quality and value. We've had industrials as an overweight for some. These are not necessarily your old-fashioned steel mills. They are developing or using automation, they are generation productivity gains. There are a lot of companies in the sector that are really capital-light; they are business-to-business services, that's the area we favor."

He is also interested in the financial sector, specifically in "a new wing of investment banking, the independent investment boutiques that started appearing before the financial crisis, but whose growth has really accelerated. And we've always tended to do financials outside of banks, where we like many zones within the financial sector. We have tended to do more agency brokers, capital market plays, we've done alternatives. We continue to like the space.

Frank discussed innovation in smaller companies, "[People] tend to think innovation is a growth thing. That it only happens in the FANGs, in all those big tech stocks, that's where all the innovations take place. But there's such wonderful innovation taking place in our side of the market today, in places that you wouldn't necessarily think of."

Read Chuck and Frank's full interview with Welling on Wall St. here. Please note that this article is part of Welling on Wall St.'s premium membership content. You need a paid subscription to view these articles.

Important Disclosure Information

The thoughts and opinions expressed in the article are solely those of the persons speaking as of March 14, 2017 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.

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 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.)

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