Legg Mason Royce US Smaller Companies - small fish across the big pond

Richard Wood | Wed 15 May 2019

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• Smaller US businesses feel positive about the future
• The fund’s provided some shelter in turbulent markets
• Manager Lauren Romeo tells us how big companies impact the smaller ones she invests in

Our view

Many US smaller companies don’t attract the attention of analysts or investors; meaning there could be opportunity to uncover hidden gems.

We think this fund’s a good option for accessing US smaller companies and it’s on the Wealth 50 list of our favourite funds. We like the Royce team’s disciplined approach, backed by bags of experience. Lauren Romeo has been at Royce and Associates since 2004 and she’s managed the fund since 2011. The firm’s founder, Chuck Royce, has been investing his client’s money since 1972.

Performance

The fund’s made attractive returns since the financial crisis but has not managed to keep up with the broader US market. Some investors will find this disappointing but we think it’s important to take the manger’s strategy into account.

Romeo looks for companies that don’t have too much debt and aims to buy shares at a price significantly lower than she thinks they’re actually worth. This often means investing in companies that are out of favour or going through a tough patch. The fund invests in smaller companies, which are higher risk than their larger counterparts.

Buying companies for less than their true value gives some margin of shelter in difficult times. But it’s a cautious approach and the fund might not keep pace with a rising market.

The benefits of Romeo’s style were highlighted towards the end of 2018 when markets did fall. The fund lost money but not as much as its benchmark. Past performance is not a guide to the future.

Past performance is not a guide to the future. Source: Lipper IM to 30/04/2019

Disruptive behaviour

Moore’s law states that computing power doubles every two years. Technology has the potential to quickly change and disrupt established industries. Romeo can’t invest in internet giant Amazon, it’s too big for her smaller companies fund, but she spends lots of time thinking about how it might impact the companies she does invest in.

Amazon recently entered the industrial supplies market and a number of the incumbents have already lowered prices. Romeo sold her investment in MSC Industrial Direct because she expects profits to come under pressure.

Though Amazon takes business from some companies, it can create growth opportunities for others. It’s started selling vehicle tyres but not all customers are comfortable fitting their own tyres. So Amazon’s teamed up with Monro. Amazon sell the tyres, Monro fits them. The more tyres Amazon sells, the more tyres Monro fit. Romeo thinks this is a good deal for Monro and she’s bought shares in the company.

Outlook

Markets are giving off mixed signals. Stock markets have delivered positive results so far this year, suggesting investors are confident. But bond markets may warn of trouble ahead. The interest rates on short term US government bonds are currently higher than on longer-term bonds. This is unusual and in the past has been a precursor to recession but there are no guarantees.

Romeo feels cautious but doesn’t think there will be a recession. She speaks to managers of lots of companies. Their opinions can serve as a useful bellwether for the state of the economy and they feel broadly positive about the future. Either way, Romeo still wants to buy shares of businesses she thinks can grow in any environment.

More about this fund, including charges

Legg Mason IF Royce US Smaller Companies Key Investor Information