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Royce Investment Partners Commentary: Deep Value Investing During the Market Downturn

Have you and your team changed anything about your investment process during the current sell-off?

Our Deep Value process has intensified, but nothing has fundamentally changed. Even with our team members working from home, our schedule and practice remain the same. We meet every morning to review the entire portfolio in order to assess the valuations of current positions, sizing, and potential additions and subtractions.

Have you been doing anything differently in this environment?

I'd say that we're doing things more intensively rather than differently. During times of extreme volatility such as what we're now experiencing, we concentrate on setting up the portfolio to capture the most upside when the market recovers. Our current day-to-day process now includes more time spent on determining how to best position the portfolio for a recovery. We're using cash from names that are close to fair value as the means to buy those that can provide better returns over the cycle, and we will not get defensive.

Our opportunistic Deep Value process has been in place for more than 20 years, and the team has experienced many extreme markets--such as the 2008 Financial Crisis. During severe (and less severe) downturns, we have successfully taken advantage of falling share prices to enhance long-term results.

What are your thoughts on how small-cap and large-cap will perform in the downturn?

Outside of the human tragedy, the overall impact on equities has been, and continues to be, indiscriminate selling. As in the past, we expect that small-caps may decline more than other areas of the market because small- and micro-caps have less liquidity. We also think that a recovery would likely first favor large-caps before then broadening to encompass the small-cap companies.

How have you been investing so far?

As always, we make changes--some significant--by reducing positions where we think upside may be modest or limited and increasing or adding new positions that can maximize returns. It is common for us to add new names that show promise for significant appreciation as a result of increased volatility.

As I mentioned above, we have a lot of experience in markets such as the one in which we now find ourselves. The kind of small- and micro-cap stocks that make up our portfolios have historically tended to fare poorly in extreme down markets. This is not just because of liquidity but also the fact that many of these names are turnarounds or are facing other short-term issues that give most other investors pause. But we work to take advantage of these situations. Many of the positions that we're adding to are priced far lower than what we think is fair value, so we are using this time to increase the spread between what we are paying and what we suspect these companies will eventually sell for.

Nearly everything in the small-cap market looks cheap these days, so we examine companies on a name by name basis. We do not think in terms of sectors but have more of what we like in housing, technology, and healthcare but not much that interests us in retail, energy, or banks.

As difficult as the current period is--for reasons that go beyond the stock market obviously--we're investing actively knowing that the situation, for all its uncertainties, is finite. And we're trying to position the portfolio to enjoy a strong rebound when the markets recover.

The thoughts concerning recent market movements and future prospects for small-company stocks are solely those of Royce Investment Partners, and, of course, there can be no assurances with respect to future small-cap market performance.

This article first appeared on GuruFocus.