Finding Small cap Opportunities Amid International Economic WeaknessRoyce Funds
David Nadel discusses three international small-cap holdings and how our Quality at a Reasonable Price strategy has performed recently.
How has the strategy performed over the last few quarters?
Well it’s been very pleasing the last couple of quarters. We had kind of a fair amount of volatility just over that short period of time, so the fourth quarter of 2018 obviously a big down quarter. We were pleased to outperform our benchmark, preserving capital basically just by losing less than the benchmark did.
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But then we got a snapback rally in the first quarter of 2019. It usually tends to be the case that those snapback rallies are led in the market by the type of investments that International Premier tends to deemphasize. Things like deep cyclicals, emerging markets, commodities. So we were pleased but a little bit surprised, by that juxtaposition of those two quarters.
Which market environments are challenging for the strategy?
We’re on our ninth year now with the strategy, so there’s a fair amount of data to work with to understand which market environments are challenging. Since this is a high-quality focused strategy, those market environments that are challenging fall into kind of the lower quality, or more levered or more speculative bucket.
So areas like deep cyclicals, commodity businesses, low-margin, high-asset intensity, etc. EM businesses, we tend to be underweight EM. And then even infrastructure companies. It’s not common that you get an infrastructure rally, but when you do, it’s not generally great for our strategy.
Is the economic weakness in Europe creating opportunities for the strategy?
When there is economic weakness, it often benefits us because the perception is that all small-cap companies must be more cyclical than, you know, let’s say very established large-cap companies in the same sectors. So we have been able to use that perception and some of that share price volatility to our advantage in terms of the European portion of our portfolio.
Where are you finding opportunities?
One of the companies that we added on that sharp downdraft is a business we’ve been following for many years called IMCD. By description they are a distributor of specialty chemicals, including ingredients for cosmetics and food.
On the other hand, their model is really all about expertise. They have laboratories all over the world that have chemical engineers and chemists in them. So they’re able to essentially be an outsourced marketing department for their suppliers.
A lot of our companies in the business description they look exceedingly boring, and maybe IMCD is boring at some level, because it’s such a consistent producer. But I think the part people will miss with a company like that is they’ll pigeonhole it as a distributor. Distribution businesses are not normally that interesting. But you know, when you’re getting near a double-digit operating margin, you must be doing something a little different. That’s kind of the special sauce there.
There’s a couple of positions that we added in the fourth quarter. One of them really was, what we would call a boomerang, so a position that had been held before. That’s a company called Fuchs Petrolub. They are the global number one pure play lubricant business, specialized lubricant business. They compete with the large integrated oil E&P lubricant divisions, but again, they’re a pure play. A large amount of customization in the products that they’re serving, again, a big team of chemists and chemical engineers, interesting customer relationship that they have with that type of a business.
Another one that we added both in the fourth quarter initially, to the portfolio, and then continued to add in the first quarter is Loomis. And Loomis is a Swedish company. Its roots go back over 150 years. It is a global leader in the area of cash transit and valuables transit.
Article by David Nadel, The Royce Funds