Charles Royce
Pennsylvania Mutual Fund
by Marla Brill
MFI Publisher
When people think of small company value
manager Charles Royce, the smart bowties he prefers over more traditional
business neckwear often come to mind. “I went to college during the late 1950s
and early 1960s when college men wore bowties,” he says of his sartorial
preference. “I just wanted to keep the look going. They’re a more expressive
form of tie, and you can’t spill food on them.”
Distinctive neckwear was a Royce
trademark well before 1973, the year he took over the tiny Pennsylvania Mutual
Fund from a colleague. At the time, the 33-year-old Royce was an analyst at a
small regional brokerage firm who, despite his seat on the board of the fund,
had strong doubts about the momentum-driven style of investing its manager
practiced. When he assumed control, he began weeding out the sixties-era “go-go”
stocks that populated the fund, substituting them with what he considered a more
resilient breed of small company stock.
“I wanted to invest in small companies
that pay attention to things like balance sheets and cash flow,” he says. “It
wasn’t a matter of shaping the fund into a “growth” fund or a “value” fund. It
was a matter of choosing companies that would survive even in hard times.”
Despite his efforts, Pennsylvania
Mutual’s net asset value plummeted 40 percent in 1974 in the midst of one of
history’s most crushing market downturns for small company stocks. Royce
shoulders part of the blame for the debacle, saying that he “did not make the
kind of radical surgery I should have when I took over the fund.”
That was the last year shareholders
endured a crushing blow like that. Since then, the fund has had only two down
years—in 1994, when it inched down less than one percent, and in 1990, when it
dropped 11.5 percent.
Credit at least some of that downside
resistance to Royce’s preference for “low expectation” stocks that the market
has whacked because of short-term bad news. “An ideal situation is where a
company with great financial characteristics gets hammered by 50 percent when
its earnings estimates fall short by 5 or 10 percent,” he says. “That’s when we
like to move in.”
But the kinds of more mature,
bread-and-butter small companies that Royce favors over high-growth, high P/E
tech plays don’t bring down the rafters in strong bull markets. As a Morningstar
report on the fund sums it up, Pennsylvania Mutual “concentrates on minimizing
risk in its portfolio of small-and micro-cap stocks. Although its returns aren’t
anything special, the fund holds up better than most when the markets turn
south, making it a decent choice for conservative investors.”
“There’s a tradeoff that comes with low
risk,” says Royce. “In high-return periods for the market, we’ll lag. And that’s
okay with us.”
Where most fund marketing literature
stresses market-beating returns, this one highlights downside protection. Recent
promotional material points out that Penn Mutual has had positive returns in 24
of the last 27 calendar years; it has outperformed the Russell 2000 for that
last three, five, 10, 15, and 20-year periods; and it has outperformed the
Russell 2000 during all ten major downturns over the last 15 years. All good
points, if an investor prizes a downside cushion above owning a fund that’s at
the top of the performance charts.
But in the late 1990s, when much of the
retail public could give a hoot about downside protection as high P/E tech
stocks soared, the promise of a safer ride wasn’t enough to keep investors
interested in Pennsylvania Mutual and other Royce funds. Assets in Penn Mutual,
which stood at about $500 million in 1997, had shrunk to $354 million at the
beginning of last year. Though the impact was less dramatic at other Royce
funds, their inflows declined as well.
More recently, the upturn in small
company value stocks—and the accompanying uptick in fund performance--has helped
reverse the trend. Today, Penn Mutual has $568 million in net assets. This year,
says Royce, “we’ve had decent inflows across the board in all our funds.”
Next: Dancing With A New
Partner |
