What do you see as the most important changes in small-cap investing since you took the helm of what is now Royce Pennsylvania Mutual Fund (“Penn”) in November of 1972?

Chuck Royce: I’ve seen many, but I think the most significant has been how the asset class has evolved over the last five decades. Small-cap has gone from being obscure and misunderstood to an established and institutionally recognized asset class. When I began my career as an analyst, small-cap was not seen as an asset class of its own—that is, one that had its own distinctive investment attributes, performance patterns, etc. To the degree that it was recognized, investors saw it as the place you went to find one or maybe a few highly risky growth stocks. With Penn, I was trying to do something innovative that went against the current.

When you first began to manage Penn, were you using a risk-conscious approach?

CR: Not entirely, no. The collapse of the “Nifty Fifty” market in 1973-74 was what convinced me to be vigilant about risk and seek out companies with attractive valuations, strong fundamentals, and high company quality. It was in many ways similar to the current period. First, the “Nifty Fifty” was a group of large, mostly multinational firms that were thought to be both a sure and safe route to growth—similar to the “FAAMG” group (Facebook, Amazon, Apple, Microsoft, and Google) today. The country was also challenged by inflation, recession, and rising energy prices.

How Things Have Changed…

Source: USA Today, www.energy.gov, and www.bea.gov

How did this difficult period change your approach to investing?

CR: Few things will lead you to reevaluate your investment discipline more than deep losses. Penn’s dismal results in 1973-74, when it fell 48.5% and 46.0%, respectively, led me to evolve my approach. I became convinced at that time that successful long-term investing was as much a matter of preserving capital as growing it. A strategy that lost less during downturns and was at least competitive in more bullish periods could provide strong absolute returns while also being likely to beat its benchmark, in particular over full market cycle periods. The second lesson was that a risk-conscious approach could be very effective with small-cap stocks—possibly even more so than in the more established, larger asset classes because small-cap was so inefficient and garnered very little institutional attention. I believe these core tenets of our investment discipline remain as relevant today as they were then.

Was it surprising that more investors didn’t look to small-caps during these years?

Chris Clark: The perception that small-cap was a highly risky asset class was so strong that it’s not entirely surprising. Even on the heels of the success that pioneers like Chuck enjoyed, there were few competitors. There were only 13 open-end small-cap funds in 1972, 17 in 1982. The total began to climb in the ‘90s, with 121 funds at the end of 1992. The next 10 years saw the most explosive increase—there were 553 funds at the end of 2002, and only 556 at the end of 2012. That number had fallen to 501 as of the end of September 2022. Of course, ETFs devoted to small-cap investing have proliferated over the last 10 years, going from 44 in 2012 to 113 at the end of September. Even with this remarkable growth, the asset class remains the most inefficient, labor intensive, and exciting segment of the equity markets.

Growth in the Number of Open-End Small-Cap Funds
From 12/31/72 through 9/30/22

Source: Morningstar

What’s the most important lesson you’ve learned from 50 years of managing the Fund?

CR: There have been many, but if I had to mention one, it’s the importance of staying invested for the long run. So many market extremes are unimaginable—until they actually happen. Most, if not all, investors never see these kinds of seismic events on the horizon. Stagflation in the 1970s, the “Death of Equities” and Black Monday in the ‘80s, the currency crises of the ‘90s, the Internet Bubble in the Aughts, the Great Financial Crisis, and Covid were all shocks to varying degrees. They all frightened or discouraged investors, but markets ultimately recovered and prospered. They all created rewarding long-term investment opportunities for anyone who had the stomach—and patience—to stay invested. We see the current bearish environment the same way.

In what ways has Royce changed over the years?

CC: One of the two most important changes has been the gradual and purposeful transition from Chuck leading most of our strategies—which invested primarily in U.S. small-caps in mutual fund portfolios for U.S. investors—to employing multiple portfolio managers managing a range of small-cap portfolios, still mostly focused on U.S. small-caps, to where we are today, with multiple portfolio managers and analysts managing differentiated strategies that invest in U.S., international, and/or global small-caps in a variety of vehicles available to both U.S. and non-U.S. investors. These changes have better aligned us with the evolving needs of our clients while positioning our firm to navigate the ever-shifting landscape of the investment management industry.

What was the other notable change?

CR: I would say it is the purposeful growth in the number of our investment professionals, especially the way it’s evolved so substantially over the last two and a half years, that has been most significant. This growth demonstrates our commitment to a deep and multi-generational approach to our investment teams. Thirteen of our 30 current professionals have joined Royce since May of 2020—an increase of more than 40% in our research and portfolio management talent. This growth was highly intentional and was an effort that Chris and our Co-CIO Francis Gannon were instrumental in leading and implementing as we thought about the most effective ways to ensure another 50 years of success.

Two years into the transition, have you been happy with Franklin Templeton’s majority ownership of the firm?

CC: Absolutely. Just as we were very pleased with how Legg Mason supported us as an independent investment affiliate from 2001-2020, we couldn’t be happier with our relationship with Franklin. Our status as an autonomous Specialist Investment Manager (SIMs) within the Franklin Templeton family has been as positive as we could have hoped. They are both a key resource and supportive partner, and their global distribution team continues to provide increased reach for our products as clients across the globe look to, or consider, Royce to meet their small-cap allocation needs. In addition, we now sub-advise a range of portfolios for clients in the U.K., Europe, Japan, Australia, and Canada.

What do you think makes Royce unique?

CC: Over the last 50 years, we have developed unparalleled experience in small-cap investing that provides us with a deeper understanding of the nuances and lingering misperceptions about the asset class. This experience leads to critical investment insights that can benefit our clients. We continue to thoughtfully and intentionally evolve the firm with a long-term view and a resolute commitment to remaining a pre-eminent small cap specialist. Despite all of the firm’s accomplishments over five decades, we have never forgotten that our top priority is delivering strong long-term returns to our investors, which we have been doing: For the five years ended 9/30/22, eight of our 11 open-end funds beat their respective benchmarks—which represented 82% of our assets under management at the end of September.

Any final thoughts?

CC: Chuck is the last person who’d want to mention this, but I think it’s important to note just how impressive Penn’s record has been since he took over full investment responsibilities in 1972.

The Growth of $10,000 Invested in Royce Pennsylvania Mutual Fund
From 11/31/72 through 10/31/22

Past performance is no guarantee of future results.

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