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Royce Investment Partners Commentary: How a Changing Environment May Impact Our Small-Cap ...

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What factors made 2019 so challenging?

2019 was disappointing. Some of this disappointment came about by self-inflicted challenges, wounds. I had several stocks that disappointed, one of which, certainly in the top five, I sold, another one that I've been reducing. The remaining three, I have confidence in, and I think those were one-off issues.

We also suffered from a market that wasn't our kind of market. It was a market that was P/E driven and driven by concepts and thoughts that really are alien to our process, more growth driven, so biotech and tech did well. Biotech, we have no exposure. Tech, we had modest exposure. We think in 2020 there's a setup for that to redeem itself. And so we think the prospects looking ahead into this year are much more encouraging.

Why do you think that 2020 might be better?

2020, I think, will improve because of several things. First of all, we've seen some indication of this already starting late August into September. The yield curve became normal again. The U.S. dollar started flattening to declining. Commodity prices started firming. So there were many indicators plus economic data from around the world that suggested the economy probably had bottomed.

You have the major economies of the world increasing spending. So I think it's just going to be additive, and on top of supply constraints, if demand improves, we're going to notice that some commodities are going to be in much tighter supply conditions, and price improvements are going to occur.

Which portfolio companies should benefit from this improved environment?

We have companies in the portfolio that should benefit in that kind of scenario, supply-constrained, demand-induced scenario. One example would be a company called Huntsman (NYSE:HUN). It's a chemical company that, for many years, was run by a gentleman named Jon Huntsman. He passed away and his son, Peter, took charge. And Peter has done a metamorphosis at the company, really turned it upside down. He has gotten rid of much of the commodity--which is known in the chemical industry as "upstream"--areas, products, and has concentrated on "downstream," which is the value added, the specialty chemical products. And, in that, you have much higher margin business. It should be less prone to the big price swings.

Another one which we think has some of those characteristics is a company called Verso (NYSE:VRS). It's a paper company. They are largely in the specialty-paper and coated-paper business which coated paper goes to magazines. There's improvement coming in those industries. We also have seen a lot of European coated-paper capacity shut down. That has evolved now to a situation of a much more balanced supply/demand situation.

So, again, with the economy improving, advertising spending improving, all of these things going on, I think the outlook for coated paper has improved and Verso would benefit. So we're hopeful on names like Verso and Huntsman.

The thoughts and opinions expressed in the video are solely those of the persons speaking as of January 13, 2020 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

This article first appeared on GuruFocus.