When people think of small-company value manager Charles Royce, the smart bow ties he prefers over more traditional business neckwear often come to mind. "I went to college during the late 1950s and early 1960s, when college men wore bow ties," he says of his sartorial preference. "I just wanted to keep the look going. They're a more expressive form of tie, and you can't spill food on them."

Distinctive neckwear was a Royce trademark well before 1973, the year he took over the tiny Pennsylvania Mutual Fund from a colleague. At the time, the 33-year-old Royce was an analyst at a small regional brokerage firm who, despite his seat on the board of the fund, had strong doubts about the momentum-driven style of investing its manager practiced. When he assumed control, he began weeding out the sixties-era "go-go" stocks that populated the fund and substituting what he considered a more resilient breed of small-company stock.

"I wanted to invest in small companies that pay attention to things like balance sheets and cash flow," he says. "It wasn't a matter of shaping the fund into a 'growth' fund or a 'value' fund. It was a matter of choosing companies that would survive, even in hard times."

Despite his efforts, Pennsylvania Mutual's net-asset value plummeted 40% in 1974 amid one of history's most crushing market downturns for small-company stocks. Royce shoulders part of the blame for the debacle, saying that he "did not make the kind of radical surgery I should have when I took over the fund."

That year was the last one in which shareholders endured such a crushing blow. Since then, the fund has had only two down years-in 1994, when it inched down less than 1%, and in 1990, when it dropped 11.5%.

Credit at least some of that downside resistance to Royce's preference for "low expectation" stocks that the market has whacked because of short-term bad news. "An ideal situation is where a company with great financial characteristics gets hammered by 50% when its earnings estimates fall short by 5% or 10%," he says. "That's when we like to move in."

But the kinds of more mature, bread-and-butter small companies that Royce favors over high-growth, high P/E tech plays don't bring down the rafters in strong bull markets. As a Morningstar report on the fund sums it up, Pennsylvania Mutual "concentrates on minimizing risk in its portfolio of small- and micro-cap stocks. Although its returns aren't anything special, the fund holds up better than most when the markets turn south, making it a decent choice for conservative investors."

"There's a tradeoff that comes with low risk," says Royce. "In high-return periods for the market, we'll lag. And that's OK with us."

Most fund-marketing literature stresses market-beating returns, but Pennsylvania Mutual's highlights downside protection. Recent promotional material points out that the fund has had positive returns in 24 of the last 27 calendar years; it has outperformed the Russell 2000 for the last three-, five-, 10-, 15- and 20-year periods; and it has outperformed the Russell 2000 during all 10 major downturns during the last 15 years. All good points, if an investor prizes a downside cushion above owning a fund that's at the top of the performance charts.

But in the late 1990s, when much of the retail public could give a hoot about downside protection as high P/E tech stocks soared, the promise of a safer ride wasn't enough to keep investors interested in Pennsylvania Mutual and other Royce funds. Assets in Penn Mutual, which stood at about $500 million in 1997, had shrunk to $354 million at the beginning of last year. Though the impact was less dramatic at other Royce funds, their inflows declined as well.

More recently, the upturn in small-company value stocks-and the accompanying uptick in fund performance-has helped reverse the trend. Today, Penn Mutual has $568 million in net assets. This year, says Royce, "we've had decent inflows across the board in all our funds."

Those inflows eventually may be affected by Baltimore-based Legg Mason's announcement in July that it was buying Royce & Associates for $115 million, much of it in Legg Mason stock. For its part, Legg Mason will get an investment firm with a solid niche in small-cap value investing and $5.3 billion in managed assets, mainly through the 12 Royce mutual funds.

The deal, still subject to approval by Royce shareholders at press time and slated to close in October, would make Royce & Associates a wholly owned subsidiary of Legg Mason. That firm has $145.6 billion in assets under management, including approximately $29.5 billion in proprietary mutual funds.

Royce & Associates decided to look for a corporate partner about a year ago, a move that its 61-year-old founder says he made to help ensure continuity. "I didn't want to be in a wheelchair making decisions that could lead to a shotgun wedding," he says. "Doing this while I'm still active at the firm helps ensure that the next 20 years will be as stable and productive as the last 20."

Investment strategy and key personnel will remain intact, Royce insists. He has no plans to retire any time soon-an important point to shareholders, considering that he is named as lead manager of five of the firm's open-end mutual funds, including Pennsylvania Mutual, Royce Total Return, Royce Premier, Royce Select and Royce Trust & Giftshares, as well as three closed-end funds. He expects senior portfolio managers Whitney George, manager of the Royce Low-Priced Stock Fund and Royce Micro-Cap Fund, Buzz Zaino, manager of Royce Opportunity, and Charlie Dreifus, manager of Royce Special Equity, to remain at the firm.

The funds will retain their management fee structure after the transaction is completed. No additional levels of sales charges or expenses will be added to current fund share classes, and they will remain available to new investors. This policy contrasts with that of other no-load firms such as Scudder, Founders Asset Management and Mutual Series, which imposed sales charges on their funds after being purchased by larger load-fund complexes. Royce didn't want that to happen at his firm.

"Most mutual fund mergers involving no-load funds have meant dancing with a load-fund giant," he says. "It changes the entire character of the fund. Staying no-load is important because it means acting responsibly toward new and existing shareholders. I want to maintain a setting where the firm can grow appropriately and not be forced into growing too quickly."

For a small-cap manager like Royce, keeping funds at a manageable level is important to avoid the liquidity issues that surface when big buyers gobble up small-company stocks. Royce says he is "highly sensitive" to such concerns, but he has no plans to close any of his funds to new investors. He maintains that with the firm's staff of 15 professionals, keeping track of the 200-plus stocks in some of his funds-about double the number of the average stock fund-"isn't that hard."

Fund size probably isn't an immediate concern to William Miller, the legendary manager of the $11 billion Legg Mason Value Trust. Miller, who soon will share a corporate parent with Royce, searches for stocks he considers undervalued but roams the large-cap universe to find them.

Although Legg Mason Value boasts a strong long-term track record, beating the S&P 500 Index every year in the 1990s, Miller raised more than a few value-purist eyebrows when he maintained significant positions in what many considered growth issues, such as America Online, in the latter part of the decade. The strategy bumped up performance, but it also left some wondering whether the fund's value label really reflected its manager's strategy.

Royce's strategy fits more neatly into what many consider the more traditional definition of value, and like others in that camp, his technology-light funds largely sat out the sector's recent boom and bust. Yet he isn't about to second-guess Miller's choices or engage in a debate over the true definition of an undervalued stock.

"Value investing isn't about sticking to any formula," he says. "It's about looking at great companies and buying them when their risk is lowest."