What drew you to investing?

Before I embarked on my investment career, investing seemed like one of the few careers in which one never stops learning—which has been indisputably true for me. Another big allure of investing is that much of the accumulated knowledge is timeless, especially when viewed and applied in the context of business cycles. Lastly, investing is at once humbling and exhilarating. Any flaws in process and judgement are laid bare when an investment thesis is proven wrong—and the feeling of being proven right never gets old.

What appeals to you most about investing in small caps?

Smaller companies have always been under-researched to some degree and are becoming increasingly so. They are also often misunderstood for the simple reason that the fundamentals of these businesses have not been examined widely and repeatedly, unlike those of large companies. The most troubled small caps are usually left for dead, with not much regard paid to the ongoing actions to fix their issues, in effect perpetuating their current woes in their valuations. In practice, however, companies rarely stand still and watch reality unfold. When incentivized appropriately, companies hire new management, cut costs, realign investment priorities, and improve communication to investors. Hence the “returns on good research,” as it were, can be quite high for a thoughtful and patient small-cap investor.

What drew you to Royce?

Royce’s long history and stellar reputation as a value-oriented small-cap manager is incredible. What also really struck me as I met several people throughout the interview process was evidence of Royce’s culture that underscores the experience of its investment staff. A high degree of openness, simplicity, and humility were consistent threads that ran through every interaction I had.

I started my professional life as an engineer in India and took a meandering path to becoming an investor, investing in several geographies and gaining exposure to different investment styles over the past decade. This journey gave me a diverse perspective and opened my thought processes—both of which have been welcomed and encouraged at Royce.

What was the appeal of Small-Cap Opportunistic Value Strategy?

The Opportunistic Value Strategy itself is a great attraction for me because, given its breadth, it demands a clinical focus on the key drivers of each business we hold. Unearthing the few fundamentals that matter and understanding them deeply, while cutting out the noise, is a challenge I savor. The other draw was the contrarian nature of the Strategy. It demands the ability not to just stomach volatility, but to befriend it when the near-term outlook seems the bleakest—and to demonstrate the patience to wait for the business to improve. When I graduated from business school in 2009, I mustered the conviction to wait out the Financial Crisis before becoming an investor rather than take the path of least resistance back to the technology industry. Looking back, it really shaped me. I learned, in an unforgettable manner, what the bottom of a cycle feels like and that the bottom is not perpetual. I would venture to say that there is an unforced stylistic and personality fit with the strategy.

What are the most critical metrics and attributes you look for in a company?

I like to traffic in change. Let’s take a turnaround situation as an example. I first look for the necessity for change in the business. At this stage, I’m really looking for breaks in the company’s historical patterns of growth, earnings, returns on capital, and capital allocation. The key question is whether the underlying business itself is broken or if the dislocation is temporary and/or fixable. Next, I identify the key changes needed for the investment to work. Then I do the work to decide if the underlying drivers to effect such change are within management’s control and caliber, and if management is incentivized correctly. When I evaluate management teams, I listen for clarity of thought and pragmatism in their strategy rather than salesmanship. Once an investment is made, I stay focused on the few factors that should demonstrate progress in the right direction and validate the mean reversion thesis.

Another area that I think offers a very different flavor is cyclicals. I just love how history repeats itself reliably in cyclical industries. Taking commodities as an example—a period of high demand, strong prices, and higher-than-average profitability is almost always followed by new capacity that floods the market. This oversupply causes prices to fall and sends the highest cost players into peril. Getting to know the small companies that can weather a cyclical trough, be it because of their insulated niche, reasonable cost structures, or relatively lower indebtedness, is akin to separating the wheat from the chaff. This is a particularly rewarding endeavor because such companies do become unjustifiably cheap, albeit very briefly, and I want to act quickly when they do.

Are there other themes you examine?

Interesting opportunities arise when I uncover hidden gems that are not easily discernible from the high-level numbers reported by a company. Examples could be a new product which is small today but that can scale in the long term, a smart bet on a new and growing end market made by an otherwise sleepy company, fully depreciated and vastly understated assets on a company’s balance sheet, etc. Even more powerful is identifying companies that are making gradual but meaningful, often simplifying, changes to their underlying plumbing that can render them a leaner, meaner competitor over time. Such changes are not always appreciated by investors until after the fact. While not easy to find, these hidden gems often end up providing very asymmetrical returns while posing relatively low risk compared to investments that require a reversion to the mean or a cyclical recovery.

How do you see the small-cap market currently? In which industries are you seeing the most attractive valuations?

The small-cap market is almost always a stock-picker’s world. It offers opportunities to those willing to peer under the hood and take a closer look at underfollowed businesses. A case in point is SPACs. Several companies that merged with a SPAC to go public are trading well below their IPO price today. Sifting through this very large universe is proving to be a worthwhile exercise. We’re finding many businesses that have good long-term prospects, but whose stock prices are currently hampered by a variety of reasons.

A few common themes are the technical selling pressures following the merger as promoters or PIPE investors book early profits. It’s also not uncommon to see a string of earnings disappointments owing to temporary cost pressures from current global supply chain issues, or the market’s disenchantment with the need for an investment phase, perhaps after a period of underinvestment under private ownership. These price dislocations have the potential to be very lucrative if we stay focused on the favorable long-term fundamentals and take advantage of their near-term price volatility.

Finally, discrete opportunities are also available in companies that have used COVID-19 as an opportunity to permanently lower their costs. This is particularly true of companies in industries where demand was hard hit by COVID and has been slow to recover, such as the aerospace supply chain, live events, travel, etc. To the extent that companies are not getting credit for their improved cost structures in their earnings estimates and valuation, they could produce positive earnings surprises and attractive returns as the supply/demand dynamics normalize.

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