Royce: Market Getting Back to Normal

Karin Anderson: Hi. This is Karin Anderson, mutual fund analyst with Morningstar. I'm here today with Chuck Royce, president of the Royce Funds and portfolio manager of several funds at the firm.

Hi, Chuck. How are you today?

Chuck Royce: Great.

Anderson: Great. Thanks for being here. Maybe you can talk to us first of all about kind of the state of the market right now. We've had several months of a strong rally. You've talked to your shareholders about all the deep discounts are a thing of the past at this point. So what does that mean for the funds that you run?

Royce: I think it opens up a different platform, a different opportunity set. It's not, of course, anywhere as near as strong an opportunity that it was six months ago.

We virtually had a straight-up run. I do think we're in a now evolving sort of more normal period. A more normal period, I think, in the market will have, from time to time, 5%, 10% corrections. There will be more of a specific opportunity at the specific stock level. That's something we certainly look forward to.

We're always interested when the market has misinterpreted short-term data, an earnings miss, et cetera, and has failed to recognize the long-term opportunity. That's our cup of tea.

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So this is, I think, a transition moment back to a more normal market. At the end of the day, of course, the economy counts, but I think the market is still willing, at this point, to look ahead. Look ahead not just in the next quarter or two, but look ahead in the next couple years. And that's what we are doing.

Anderson: OK. And so, I suppose some of the funds that are more focused on dividend payers, for example, like total return and dividend value, these are funds that have maybe not looked so good year to date.

Royce: They're certainly performed on a relative basis--they're up 20%, 30% on a year-to-date basis. But on a relative basis to some of our riskier funds, and to some of the more riskier parts of the marketplace, the riskier parts of the marketplace performed the best. Low-priced stocks performed the best. Non-earning companies performed the best.

But I do think we're evolving back to where quality and dividend paying will have a real value in the next couple of years. So I do see that trend changing.

Anderson: OK. And maybe you could also speak to some areas that you've maybe avoided in the past year, because it's too hard to tell who the survivors will be. Banks are the easy example.

Royce: Yeah, banks. We neither went into this crisis with a lot of banks--we had some, very, very few--nor did we take advantage of the opportunity. It's just not an area that we feel we have the kind of deep superior knowledge to make that distinction.

And I personally, in a political sort of macro sense, think that the bank restructurings will go on for years, many years, and that the number of banks that have gone out of business, although it's 100 now, will be multiple hundreds by the time this is over.

And I have a kind of personal feeling is that we have too many banks to begin with. So I think this restructuring will go on for a long time, and it's very hard for us to sort out winners/losers here. A lot have bounced, but it's just not an area that we decided to do. So we stick to our areas of competency.

Anderson: OK. I'd also like to talk about Pennsylvania Mutual Fund a little bit. This fund has a 30-year track record. To someone just looking at it for the first time, they'll see a huge basket of stocks, about 500 or so stocks. And its performance long term doesn't look index-like. It doesn't have characteristics of an index.

I'm wondering if you can just talk to us about your strategy there, being you can either be price sensitive or position sensitive, because there are hundreds of positions there in that fund that are tiny.

Royce: Right. Well there are kind of two or three ways to look at it. One is 80% of the stocks really are in the top 200 names. 80% of the portfolio. So really, what drives the performance is the top 80%, the top 200 stocks.

And that's a fairly conscious decision on our part. Now what is the remaining is many, many stocks, 300 stocks, that represent stocks going in the portfolio or out of the portfolio. They're often sort of our R&D pool, or they are often a stock that we just haven't been able to get the right price on, or we started with the right price but only got a small position.

So it represents a variety of things that go on. I'm comfortable with managing a large sort of tail in the portfolio. We certainly actively watch it and are always thinking about what I call "up or out." But in fact, what we're really trying to do is find the right price and the right conviction level for that stock as we get to know them.

Anderson: OK. Great. Thanks for your time today, Chuck.

Royce: Great. Thank you.