"Small is Beautiful," says Investing Legend, Chuck Royce (WealthTrack)

CHUCK ROYCE: It has been a bull market for most of the 35 years, although obviously we have had bear markets from time to time, but in general we have done, I don’t know, 12-14% for most of our funds over the course of a lifetime of the funds. It’s been a good market. We have beaten the index. I do want to beat the index, though, with less risk, less volatility. At the end of the day you can measure the volatility and you can measure how you do in down markets. So we describe those down-market periods and the goal was not to go down as much, pretty simple. Now in our stock selection, though, and obviously stock selection is the first part of constructing a portfolio, we start with the risk end of things rather than the return end of things.

CONSUELO MACK: Meaning?

CHUCK ROYCE: Meaning, in a new idea, what is the deal here? How can we lose money? We can lose money because the company has too much leverage. We could lose money because the business strategy is cuckoo. We could lose money because the management appears to be not consistent with what we want managing our company. We could lose money in lots of ways. We think deeply about all the risk factors before we deal with the return factors. So in the process of selection, and we’re talking risk first, return second; if you eliminate or can understand what we believe to be the risk factors, we deal with the return factor. We want to make a lot of money. We want to double our money over three to five years. So we have a fairly high bar of what we want to achieve. And then we go ahead and do it and construct our portfolio. Obviously there is portfolio risk too. We want to be careful about concentration. We want to be careful about too much in any one industry. We’re thinking. I think, appropriately about the portfolio risk. But that comes after the stock risk.

CONSUELO MACK: Looking at small caps as a sector, for instance small caps have outperformed large cap companies now for quite a long period of time.

CHUCK ROYCE: Certainly the last decade was a dramatic out-performance.

CONSUELO MACK: So how risky now is the small-cap sector?

CHUCK ROYCE: I think that is probably the wrong question. The wrong question is, what will the returns be in the next 10 years and who is likely to do better, large caps or small caps?

CONSUELO MACK: Thank you. That’s a much better question.

CHUCK ROYCE: I don’t think it’s terribly critical, though, as to who does better, really, but I think it is entirely possible that we are going to have returns that will be in between the last decade and the prior decade. The prior decade was a hot decade, the ‘90s. Large-cap did very well. There was a moment where the S&P had 20%-plus five-year returns towards the decade. Completely the opposite took place the last decade. So we’re going to be in between. We are going to be 6 to 9% returns in my judgment overall, for the overall market, and I think small caps will be higher from time to time and lower from time to time. Large caps will do the same. They’ll be much more rotation in this decade. The large-cap champions are waiting on the sidelines for their turn at bat, and I think it will happen certainly from time to time.

CONSUELO MACK: A couple of themes and you just mentioned one of them. Number one, global is core to investment success now.

CHUCK ROYCE: Yes.

CONSUELO MACK: I think a lot of us who aren’t that familiar with smaller companies stocks, don’t realize that-- is there a vast array of opportunities in international companies as well as domestic ones that do business internationally?

CHUCK ROYCE: Yes. I believe there is. I think that will be an evolving trend in the next 10 years. There are not many focused small-cap, non-U.S. funds. We’re going to have three or four of them where we just focus on the smaller companies in non-U.S. settings. I do believe that is going to be very important, quite similar to the growth and attention to the small caps here that took place over 30 years. I can see that happening in the next 10 or 15 years abroad. The numbers are staggering: 30,000 smaller companies around the world, plenty of opportunity. We are just beginning that process, although we’ve been at it for five, eight years. We are just beginning to sort of build our expertise in that.

CONSUELO MACK: Where are you finding the best opportunities? Are there particular countries that happen to be more friendly to small businesses?

CHUCK ROYCE: We didn’t do that from a top-down basis. There are people that believe that you start the top with currencies and look at the countries, et cetera. We did it from the bottom up. We did it stock by stock, and we picked Europe really first because we had some folks that were very knowledgeable about Europe and we were lucky enough to trip across a couple of people who now work for us full-time who had a Europe-centric background. So we started with Europe. We have been very pleased with how that went. We have a European small-cap fund that is three or four years old that has done quite well. We’ve stuck to our own basic, plain vanilla, risk aversion, margin of safety, great balance sheet, higher-quality company themes in Europe, and now we’re doing the same thing in Asia.

CONSUELO MACK: When you look at a small company, no matter where it is, how important is it that they are doing business globally? Does that matter a lot?

CHUCK ROYCE: In our own universe in U.S. companies, we do favor companies that have a global reach, no question, and we have plenty of those. Abroad, we’re very interested in of course their business strategy, and at the end of the day I’m a nut on strategy: does it make sense and how does it work? The business model of just how did they address their market. I can probably better relate to companies that have a global reach than have a local reach, but we do companies with local understanding also.

CONSUELO MACK: I know you don’t like to talk about individual stocks, but are there examples that would be kind of emblematic of a Royce company?