Compelling Company-Specific Catalysts Drive Deep Value Outlook

Royce Investment Partners' opportunistic strategy focuses on turnaround themes.

    Bill Hench

    Bill HenchPortfolio Manager and Principal

    As is always the case, we will be paying very close attention to small-cap stocks with depressed valuations. The pandemic has created many challenges in 2020—but with them has come many opportunities as well. Our opportunistic strategy looks at turnaround themes and leads us to companies with low price-to-sales and price-to-book ratios that also show a clear set of catalysts for growth. The research we did and the positions we selected during the early months of the pandemic will determine how the Fund performs in 2021. The team invested in companies that we thought would benefit from a gradual return to normal economic activity.

    In many cases, company growth has gotten better more quickly than we might have anticipated. Most of the stocks that we’ve been buying since the market began to correct in February fell to attractively cheap levels not necessarily because there was an issue with production, competition, or some other company-specific event, but rather because of factors that affected pretty much the whole market. The result was a depression in prices and multiples that had nothing to do with the fundamentals of the business. We will focus our attention on similar factors in 2021.

    Have the U.S. elections impacted our viewpoints on the above?

    We have always thought that elections have fewer long-term consequences for companies than is generally thought. It seems to us that the pieces are in place for a strong global recovery once a vaccine is ready and can be widely distributed. That, more than anything else, will determine the pace of growth.

    While great emphasis is being placed on a stimulus, we think that economic activity is returning to normal at a much brisker pace than is generally recognized. So while we agree that a program is necessary to help those people and industries that have yet to benefit from programs already in place, we disagree that a very large plan is needed to create better economic results. The federal government will undoubtedly try to choose winners through fiscal policy, but we are not trying to guess what those industries will be. Instead, we have tried to select small-cap companies that will do well with or without a major stimulus.

    What challenges or headwinds do we expect could affect small cap performance?

    Any unforeseen obstacles toward a vaccine would obviously create headwinds—and not just for the market, of course. In our experience, though, the headwinds that create the biggest challenges are those that no one sees coming or has thought about. Those shocks—the out-of-left-field events, if you will—are what hurt most, and precisely because no one has had time to plan around them or think about how to deal with them effectively.

    What are the investment opportunities you see in U.S. small-cap stocks?

    Even as the market has been recovering, we have found companies that look attractively inexpensive and capable of growth in an improved economic climate. Most recently, the portfolio management team has added several names in cyclical end market sectors. A few of the names are consumer stocks that would be immediate beneficiaries of a vaccine and a return to normal human behavior. We also saw an opportunity with an auto supplier that could benefit from growing demand for passenger and commercial vehicles, as well as the longer-term electric vehicle trend. In addition, we added a software company whose growth rate has decelerated for what we believe to be temporary factors in hopes that an acceleration could drive a much richer valuation.

    We reduced position sizes in companies where valuations have grown more expensive or where prospects for an acceleration in fundamentals has diminished. The former category includes a broad range of stocks that have deftly managed the downturn and in some cases benefited. We also believe select companies in the airline industry could receive a benefit from the vaccine as it would provide a lift to freight capacity. We note that some of the COVID-19 beneficiaries have been quite surprising, such as a COVID-19 resistant plastic that one of our stocks has created, which shows how small company fortunes can swiftly and materially change. One area where we have reduced exposure is oil and gas services stocks as the outlook remains cloudy.

    As we write this, we have just concluded a hotly contested election amid a rising number of COVID-19 cases while still waiting on a vaccine—though Pfizer, Moderna, and Astra-Zeneca all appear to be getting close. All of these macro forces create ample uncertainty. With that said, we see many opportunities to invest in inexpensive stocks with compelling company-specific catalysts. We continue to position the Fund for an economic expansion but are mindful that the pace of recovery (and its impact on the market) remains volatile. We are adding to the names we like at a measured pace. Market volatility, both up and down, disproportionately impacts our small-cap holdings. Accordingly, we diligently try to take advantage of such swings on both the buy and sell side to maximize shareholder returns.


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