Chuck Royce and Co-CIO Francis Gannon look at the recent decline and make the case for why active management looks poised to do well going forward.
Q3 hedge fund letters, conference, scoops etc
Francis Gannon: So Chuck, why don’t you tell me about the decline in the market last year and your thoughts on it?
Chuck Royce: Sure. It was a severe decline by sort of historic standards in the 26% range. That was more than we were expecting. Certainly, everybody was expecting correction. It’s sort of been probably the most predicted correction to ever happen.
FG: Where do you think we are in this road to normalcy that we’ve been talking about for a period of time now?
CR: The road to normalcy is normal returns in the market, normal rate structures and normal volatility. Well, this decline actually put two out of three in sharp focus. Volatility is certainly higher now, day-to-day volatility, month-to-month volatility. The three-year, five-year returns are coming way down. They’re now below average. You could actually argue the next five years could even be better than the last five years through December, and the short-term rates are up substantially in the last couple of years. So I think we are very much in the zone towards a normal setting, overall normal setting which is very favorable for active management.
FG: When I think about 2018, I think of it as a year where people were looking for the next recession. Do you see a recession or financial crisis on the horizon?
CR: Well, certainly headline-wise people really, really want to talk about, are we in an inverted yield curve? Are we about to have a technically defined recession? I’m not sure I have a strong point of view on that, but certainly it’s in the mix of conversation. Certainly, our accelerated growth is coming down. But I think it’s not clear whether we’re going into a real recession or not. I probably think we’re not.
FG: How would you put 2018 into perspective? Can you relate it to any other period within your career in terms of what happened and where we are?
CR: The ’87 flash crash had no economic consequences. People want to come up with an idea. They need to have a narration around it. Having a recession coming is certainly one of the conversations. As we all know, market declines often predict eight out of four recessions, and they sort over-predict possibilities.
FG: Bear markets, while painful, create a lot of opportunity for long-term investors like ourselves. Where were you finding opportunity in the latter part of last year?
CR: We found it across the board. We initiated a few new positions because we are always looking at opportunity. We certainly added to existing positions that we have a high confidence. We added in the tech and healthcare sector which were unusually punished, so we took advantage of that.
FG: How should investors think about 2019 as they look through the lens of 2018?
CR: I truly believe equities remain the single best long-term way to compound wealth, and if you can take advantage of price declines, you will enhance that probability of compounding long-term wealth. So to me it is an absolute given that you take advantage of these kind of declines.
FG: Is active management more important now than it was in previous declines?
CR: I think active management has a much better chance in lower-return periods, and we are entering a lower-return period. We are in a lower return period.
Article by The Royce Funds
