There is a debate among financial experts as to whether it is better to have a concentrated portfolio of high-conviction "best ideas" or to spread the risk across a wider number of holdings.
Hench is firmly in the latter camp, saying there can be a lot of volatility at the smaller end of the market cap scale.
"We don’t like concentration. You always get left-field events and things you never thought of," he said.
"If you aren’t concentrated, when you get those unexpected events, you don’t get crippled by them."
"With US small caps, you’re penalised more when things are going poorly but have much richer valuations when things are going well," he added.
"We’re able to take advantage of really cheap stocks – cheap ones that have a chance of getting back in the good graces of investors."
Hench highlights US-based doughnut chain Krispy Kreme, which he says was poorly managed and spent too much money on stores that were unsustainable.
However, he says that since a new management team took over, the stock has gone from $3 to roughly $14 a share.
Still, he admits it is difficult to find those kinds of recovery stories.
"It’s very difficult to turn around a company. It takes a lot of work," he said.
"What we do is try to identify the Krispy Kremes. It doesn’t always work but most of them turn around."
The $452.1m Royce portfolio is comprised of 250 to 300 stocks, a far cry from the higher-conviction styles of highly regarded managers such as Cazenove’s Paul Marriage and Franklin Templeton’s Paul Spencer and Richard Bullas in the UK small cap space.
However, Hench says he believes a diversified strategy is the best way to approach more volatile smaller companies.
The manager says no single stock makes up more than 1 per cent of the fund; its largest holding, credit enhancement firm Radian Group, accounts for just 0.78 per cent of AUM.
The fund’s top-10 holdings only make up 6.8 per cent of total AUM.
Hench says unlike in other funds, his top holdings are often not his highest-conviction bets – those tend to sit further down the fund – while those with the highest weightings are names the team is often starting to sell down.
He adds that even though the US economy is recovering, he is still able to find smaller companies based in the country that are unusually cheap.
"We’re getting very good assets at ridiculously low prices," he said.
"What we get paid for is that we’ve lived through the cycle with smaller companies before. We’re concentrating down to what will work a year or two from now."
Hench manages the US version of the fund, which has been available to UK investors since April 2011 through a Dublin-domiciled wrapper.
Since then the $452.1m fund has performed broadly in line with the IMA North American Smaller Companies sector and Russell 2000 index, gaining 26.7 per cent, according to FE Analytics.
Performance of fund vs sector and index since launch
Source: FE Analytics
The fund had a particularly strong 2012, nearly doubling the returns of the sector and outperforming the index, gaining 21.37 per cent.
Hench is bullish on the prospects of a recovery in the world’s largest economy, particularly in the technology space, where he says many smaller companies thrive, both from exposure to larger firms and from takeover potential.
"If you look at the US economy, the only things you need to know are that we are selling cars and houses; everything else is just noise," he said.
Hench is backing the technology sector and expects to see an increase in consumer spending in this area.
"Spending is going to return and we are going to keep buying things like iPads. Technology is going to do OK. It will be the best-performing sector group in the next year for us."
Telecommunications, media and technology is the largest sector bet in the fund, at 23.06 per cent.
Industrials, financials and basic materials are the next biggest sector weightings; it has a roughly equal exposure to each.
Liquidity is a major issue for small companies and Hench says it is something Royce has taken seriously.
"We’ve closed two times in the past," he said.
The Dublin-domiciled Legg Mason Royce US Small Cap Opportunity fund requires a minimum investment of $1,000 and has ongoing charges of 2 per cent.
