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We recognize that quality is a global concept, an idea that transcends borders. The same attributes that we seek in smaller U.S. companies—strong balance sheets, an established record of profitability, high returns on invested capital and the ability to generate free cash flow—are readily found in global businesses, if one is willing to look.
Global Opportunities
The number of opportunities in micro-cap and smallcap companies across the globe is vast. There are more companies from which to choose and greater total market capitalization than in the U.S. smaller-company universe. Our research indicates that there are more than nine times as many micro-cap companies—those with market capitalizations up to $500 million—outside the U.S. and approximately seven times the total market capitalization.
Similarly, in the upper tier of the global small-cap world—market caps of $500 million to $2.5 billion— there are more companies (5,230 versus 1,150) and greater total market capitalization ($5.2 trillion versus $1.2 trillion) than in the U.S. We believe that these factors present substantial opportunities to find quality businesses that are mispriced. In addition, the global marketplace generally offers higher dividend yields—an important component of total return.
Why Global Smaller Companies?
- Enormous investment universe that's comprised of more than 35,000 companies.
- Research coverage of small-caps outside the U.S. is more limited and fragmented.
- Limited institutional commitment to the asset class often creates mispriced securities.
- Evergreen universe continually replenishing itself through IPOs, spin-offs and larger companies falling in market capitalization.
- Small-cap stocks are generally used more tactically and less strategically outside the U.S., resulting in potentially higher volatility and greater valuation discrepancies.
High Quality and Ample Dividends
- The international small-cap universe is home to a number of companies that occupy #1 or #2 positions within their markets.
- Many companies boast operating histories in excess of 100 years.
- In global markets, dividends—a key indication of quality for us—are prevalent.
- Culture of paying dividends is well established outside the U.S.
- Dividend yields for non-U.S. companies are generally higher.
Our evolution to global investing is rooted in the Royce tradition of attempting to capitalize on market inefficiencies in an effort to generate strong absolute returns while also giving priority to managing risk.
Corporate Governance
International corporate governance and accounting standards have improved considerably over the past several years. Most developed countries followed the U.S.'s lead in the late 1990s and early 2000s by formalizing their corporate governance standards, so that they are now largely on par with the U.S.
In fact, Europe's accounting standards are designed to provide the information necessary for properly valuing companies and rely less on explicit rules than America's accounting system. However, we have found that corporate governance and transparency fall well below our high standards in certain emerging markets.
Our Experience
Our Experience Over the last 10+ years, we have greatly expanded our search for undervalued smaller companies by moving beyond our borders. Our initial forays into global investing generally involved companies headquartered abroad that had a strong U.S. presence. We then began to expand our scope to include companies whose activities are more global in orientation or focused in a particular overseas region.
Our evolution to global investing is rooted in the Royce tradition of attempting to capitalize on market inefficiencies in an effort to generate strong absolute returns while also giving priority to managing risk. The same attributes that we seek in U.S. companies— strong balance sheets, an established record of profitability, high returns on invested capital and the ability to generate free cash flow—are readily found in global businesses.
We believe that our disciplined, long-term approach will prove highly effective amidst the more consensus driven, growth-focused type of investing that seems to dominate fund management outside the U.S.
Hallmarks of Royce's Investment Approach
- Focus on risk—We believe that paying attention to risk does not diminish long-term returns.
- Absolute value orientation—we use a business buyer's approach as opposed to a "Wall Street" methodology.
- Long-term investment horizon—we seek to exploit inefficiencies created by short-term price volatility.
- Bottom-up approach—our primary focus is on stock selection.
- Consistent application—we apply our investment approach regardless of market movements.
- Benchmark agnostic—we select securities from the entire small-cap universe, without regard to benchmark weightings.
Enterprise Conviction
In an attempt to standardize our analysis of companies and meetings with management, we have developed a proprietary Enterprise Conviction Scoring system (ECS) for some portfolios that ranks companies based on five factors:
- Sector: Attractiveness of Sector
- Competition: Company's Competitive Position
- Operations: Operating Efficiency
- Record: Financial Track Record
- Extras: Franchise Sustainability/Corporate Governance
Companies receive a rating of 0-10 in each of the five categories, with an overall rating between 0-50. Generally, companies with an ECS of 26-50 are considered for investment.
Valuation
- Royce seeks companies trading at a substantial discount to our estimate of their intrinsic value.
- We use a valuation method based on an internal cap rate analysis that targets a 15% or greater rate of return at purchase. We calculate cap rates by dividing EBIT by Enterprise Value, which equates to a company's earnings yield before taxes and net interest.
- We also examine the returns-adjusted fair value of capital employed, a measure that helps determine where a company is trading relative to our assessment of intrinsic value.
Sell Discipline
Royce's sell discipline is a function of enterprise conviction and market valuation. We establish fundamentally derived sell triggers for each position when we first begin to buy shares. We update them regularly, so that achieving an established sell trigger results in a position review, rather than an automatic sale. We typically sell incrementally in an effort to minimize market impact and maximize exit price.
We generally sell companies when:
- They achieve or exceed our estimate of intrinsic value.
- They are acquired; we frequently sell prior to the deal closing.
- Business progress fails to track our assumptions, there is a negative change in business potential, or the financial margin of safety becomes impaired.
- Better risk/reward potential exists in another investment.
Risk Reduction Techniques
- Risk management is the core of Royce's investment discipline.
- We define risk not as short-term share price volatility, but as the threat of permanent capital loss.
We seek to reduce a broad range of risks:
- Business risk—by focusing on companies with strong balance sheets and histories of above-average returns on invested capital.
- Liquidity risk—by building positions incrementally and by buying when others are selling, and selling when others are buying.
- Valuation risk—through the use of absolute—not relative—standards of valuation.
- Qualitative risk—through extensive fundamental research and analysis, including our proprietary ECS methodology.
- Concentration risk—by generally limiting industry weights to 25% of a portfolio's net assets; emerging markets exposure to 35% of a portfolio's net assets; and position sizes to 5% of a portfolio's net assets.
Royce's Global/International Funds
DIVERSIFIED
Royce International Smaller-Companies Fund
Royce International Smaller-Companies Fund (RIS) invests in companies located outside the U.S. with market capitalizations up to $5 billion.DIVERSIFIED + DIVIDENDS
Royce Global Dividend Value Fund
Royce G lobal Dividend Value Fund (RGD) invests in U.S. and non-U.S dividend-paying companies with market capitalizations up to $5 billion.FOCUSED
Royce Global Value Fund
Royce G lobal Value Fund (RGV) invests in U.S. and non-U.S. companies with market capitalizations up to $5 billion.Royce Global Select Fund
Royce Global Select Fund (RGS) has the flexibility to invest in both long and short positions of U. S. and non-U.S. companies with market capitalizations up to $5 billion–available only to "qualified investors."Royce European Smaller-Companies Fund
Royce European Smaller-Companies Fund (RES) invests in companies located in Europe with market capitalizations up to $5 billion.Royce International Premier Fund
Royce International Premier Fund (RIP) invests in a limited number of non U.S. small-cap companies, those with stock market capitalizations from $500 million to $2.5 billion. RIP seeks companies it considers "premier," focusing on those that score in the upper investable range of our proprietary Enterprise Conviction Scoring (ECS) system.MICRO-CAP
Royce International Micro-Cap Fund
Royce International Micro-Cap Fund (RMI) invests in non-U.S. micro-cap companies, those with stock market capitalizations up to $500 million.Global Investing with Royce:
Our Competitive Advantages
- Royce is an established investment manager that has focused on smaller companies for nearly 40 years.
- We have a large and experienced investment team of 34 investment professionals.
- Our portfolio managers use a time-tested investment discipline that focuses on high-quality companies with strong balance sheets and high returns on invested capital that are trading at discounts to our estimate of intrinsic value.
- We use a bottom-up approach that features an absolute value orientation.
- Our portfolios have a long-term investment horizon that seeks to exploit inefficiencies created by short-term price volatility.
- We employ this approach consistently, regardless of market movements or trends.
Important Performance, Expense and Risk Information
All performance information in this piece reflects past performance, is presented on a total return basis, reflects the reinvestment of distributions and does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, so that shares may be worth more or less than their original cost when redeemed. Shares redeemed within 180 days of purchase may be subject to a 2% redemption fee payable to the Fund. Redemption fees are not reflected in the performance shown above; if they were, performance would be lower. Current performance may be higher or lower than performance quoted. Current month-end performance may be obtained at www.roycefunds.com. All performance and expense information reflects results of each Fund’s Service Class (Investment Class for Royce Global Select Fund). Gross annual operating expenses reflect Royce International Smaller- Companies, Global Dividend Value, Global Value, European Smaller-Companies, International Premier and International MicroCap Fund’s total annual operating expenses as of the prospectus dated 5/1/11 and include management fees, any 12b-1 distribution and service fees, other expenses, and any applicable acquired fund fees and expenses. Net annual operating expenses reflect contractual fee waivers and/or reimbursements. Operating expenses for Royce Global Select Fund include the Fund’s management fee based on 12.5% of the Fund’s pre-fee, high watermark return measured daily. The high watermark return for 2010, on which the above annual expense ratio is based was 27.2%. The management fee can vary significantly from year to year based on the Fund’s performance. The Fund’s total annual operating expense ratio of 3.53% consisted of the management fee, dividends on securities sold short, interest expense on borrowings, and acquired fund fees and expenses. Royce & Associates has contractually agreed to waive fees and/or reimburse operating expenses, other than acquired fund fees and expenses, to the extent necessary to maintain net operating expenses at or below: 1.69% for Royce European Smaller-Companies, Global Value and International Smaller-Companies Funds through April 30, 2012 and at or below 1.99% for Royce European Smaller-Companies and International Smaller-Companies Fund through April 30, 2021; and 1.69% for Royce Global Dividend Value, International Micro-Cap and International Premier Funds through April 30, 2014. Royce & Associates has contractually agreed to absorb all other operating expenses of the Royce Global Select Fund, other than dividend expense relating to any short selling activity of the Fund, acquired fund fees and expenses and interest expense on borrowing, when applicable. Acquired fund fees and expenses reflect the estimated amount of fees and expenses incurred indirectly by the Fund through its investments in mutual funds, hedge funds, private equity funds and other investment companies. Shares of Royce Global Value Fund’s Consultant, R and K Classes have higher annual expenses than the Service Class.
Investments in securities of micro-cap, small-cap and/or mid-cap companies may involve considerably more risk than investments in securities of larger-cap companies. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Funds invest a significant portion of their respective assets in foreign companies which may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic or other developments that are unique to a particular country or region. (Please see "Investing in Foreign Securities" in the prospectus.) Therefore, the prices of securities of foreign companies, in particular countries or regions may, at times, move in a different direction than those of securities of U.S. companies. (Please see "Primary Risk of Fund Investors" in the prospectus.) Please read the prospectus carefully before investing or sending money. This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. The Russell Global Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks. The Russell Global ex-U.S. Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks, excluding the United States. The Russell Europe Small Cap Index is an unmanaged, capitalizationweighted index of European small-cap stocks. All index returns include net reinvested dividends and/or interest income.
Important Disclosure Information
The thoughts concerning recent market movements and future prospects for international small-company stocks are solely those of Royce & Associates, and, of course, there can be no assurance with regard to future market movements.
This piece must be accompanied or preceded by a current prospectus for the Funds. Please read the prospectus carefully before investing or sending money. International and/or small-cap and micro-cap companies may involve considerably more risk than investments in securities of larger-cap companies domiciled in the United States (see “Primary Risks for Fund Investors” in the respective prospectus). Distributor: Royce Fund Services, Inc.
Distributor: Royce Fund Services, Inc.
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Royce & Associates, LLC, 745 Fifth Avenue, New York, NY 10151, (800) 221-4268. All rights reserved. Distributor of The Royce Fund and Royce Capital Fund: Royce Fund Services, Inc., a wholly owned subsidiary of Royce & Associates. The Royce Funds are offered and sold only to persons residing in the United States and are offered by prospectus only. The prospectuses include investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing. View our Policies & Procedures, including, among others, our Sarbanes-Oxley Code of Ethics, Privacy Policy and Proxy Voting Guidelines and Procedures.