In the year> and a half since the crash-and indeed in much of the past decade-few sectors have done better than the little guys. Operating in the shadows of larger investments, so-called small-cap stocks led the pack when the market began its unprecedented upward spiral in March 2009 and continued rising in the fall. Whitney George's Royce Low-Priced Stock fund (RYLPX)
George, 51, attributes the success of smaller companies to a nimbleness that allows their CEOs to spot and react to the changing business cycles ahead of the game. Royce & Associates (LM),
Yet skeptics say George, recently promoted to share the "chief investment officer" title with company founder Chuck Royce, has a tougher job ahead. Royce Low-Priced Stock, along with many of Royce's 29 other mutual funds, has benefited from a brisk tailwind in recent months. Now some experts say it's time to turn to bigger blue-chip stocks that haven't gained as much. "Smaller caps may be losing some steam," says Morningstar (MORN)
George isn't worried. "What people don't realize is that smaller companies do better in a more difficult economic environment," he says. In other words, in today's economy. What's more, he says, smaller companies typically have more flexibility than big companies and can quickly cash in on innovations. He has some history on his side: A $10,000 investment in small caps in December 1925 would have grown to $58 million by June 2009, compared with $21 million for a similar investment in the S&P 500. More recently, small-cap stocks as a group are up more than 70 percent over the past decade, while the S&P 500 is actually down over the same period.
As a retail stockbroker in the early 1980s, George says he once pushed popular, even faddish, stocks for Oppenheimer & Co. (OPY)
Once housed in a frumpy former shoe showroom, Royce & Associates recently moved into glamorous new digs in midtown Manhattan, with a polished marble reception area and 24th-floor views of Central Park. George recently sat down to a spinach-wrap lunch and, in between bites, explained why he thinks small-cap stocks still have plenty of momentum. Of course, you still have to spot the right targets. "I like to buy ugly ducklings and watch them turn into swans," he says.
SMARTMONEY: Given their long run, why should we still invest in small stocks?
WHITNEY GEORGE: Small stocks as a group are more volatile. That's fine. What people don't realize is that smaller companies do better in a more difficult economic environment. Larger caps do better in robust economies like the 1990s.
SM: That sounds like a dire forecast for near-term economic growth.
WG: Inflation is going to be a bigger issue. There's money sloshing around that will create a bubble someplace. You saw it in real estate. That's why we continue to be interested in hard assets: mining, energy, industrial companies. We like companies that make products sold around the world, taking advantage of a lower dollar. We like fixed things that have a place and cost and are finite in quantity-because the money we are using to buy them is somewhat infinite now. Stocks are the place to be, and small stocks, better.
GrafTech International (GTI)
SM: Is it common to revisit old favorites? Is this part of your strategy?
WG: We get to know the companies and management well over the years. When they go down, we start buying. We know we'll never get the exact bottom, but we keep feeling for it. When companies get close to their targets, we'll nibble at the position. We don't want any stock to get over 2 percent of the portfolios.
SM: Warren Buffett has said diversification is for dummies, and I know you're a Buffett groupie.
WG: Right, but look at how many companies he owns in Berkshire Hathaway (BRK.A),
SM: More than a year ago, you predicted gold would rise. Are you still a gold bug?
WG: Talk about being in the right church but the wrong pew. Instead of buying physical gold, we bought mining stocks like Ivanhoe Mines (IVN)
SM: Is silver also precious?
WG: Silver is going to go up. Unlike gold, silver has industrial uses, and it's not that much more plentiful than gold. It's used in electronics and has antibacterial properties, which is why they are putting it into bandages and T-shirts. Pan American Silver (PAAS)
SM: Is there a variation on the hard-assets theme?
WG: You gotta heat, you gotta eat, and you gotta save some money. We like energy, food and asset-management stocks.
SM: First heat.
Unit Corp. (UNT)
SM: Now eat.
WG: We like fertilizer, eggs and chickens. The stocks are trading at 50 to 60 percent of their value and have little debt. We like fertilizer companies, among them Intrepid Potash (IPI),
SM: You like asset-management companies, too?
WG: We have always loved asset management, except you couldn't afford to buy the stocks before. They are financial stocks without leverage and will gain because people have to save. Federated Investors (FII)
SM: What do you like overseas?
WG: It used to be the European market followed the U.S. market, but that's not the case anymore. There are no great bargains in Western Europe. We like Korea, Hong Kong and China. We especially like Hong Kong, where you can buy the shares of the exact same companies available in China. The Chinese shares can be more expensive than Hong Kong because of China's captive audience. Our China investment take is the opposite of what it is in the U.S. Before you get to hard assets, you'll see growth in domestically consumed business services like health care, education and technical services. We like asset-value-management, biopharmaceutical and forestry stocks.
SM: What about Japan?
WG: We had some Japanese banks. They did really badly. They lost money, and we learned that in Japan, shareholder return is not a big priority-at least in the small-cap world. We don't always get it right.