Royce's Newest Offerings In the Global/International Lineup

David Nadel

David, with the addition of these three new funds that focus on smaller company stocks overseas, The Royce Funds lineup now includes six portfolios that focus on equities of non-U.S. companies. Why has the firm made such a significant expansion there?

We have been seeing lots of good opportunities outside of the U.S. for many years, and we have been steadily building our non-U.S. exposure in our domestic Funds since 2000. At first, this was driven primarily by our interest in the Natural Resources sector, and then later in industrial materials businesses outside of the U.S. 

We have a very disciplined stock selection methodology, which works every bit as well abroad as it does in the domestic markets. The more we learned about many non-U.S. markets, the more we liked. It's an enormous investable universe, with a long list of what we think are great foreign small-cap stocks. We are very pleased that we now have a venue for them.

Tell us about the new Funds.

Royce International Premier Fund [RYIPX] is comprised of companies that we consider to be "premier"—those that have excellent business strengths and/or prospects for growth, high internal rates of return and low leverage, and that are trading significantly below our estimate of their current worth. This is a relatively concentrated portfolio—with fewer than 100 stocks in which we have high conviction. I serve as the Fund's Portfolio Manager. George Wyper, who has many years of experience investing in international stocks up and down the market cap scale, serves as Assistant Portfolio Manager.

Royce International Micro-Cap Fund [ROIMX] made a lot of sense to us because there are so many micro-cap stocks outside of the U.S. Our research indicates that there are nearly four times the number of micro-cap companies in the developed international universe, with about three times the total market cap of the U.S. micro-cap universe. It's a massive universe of stocks. A lot of micro-caps, which we define as those companies with market caps up to $500 million, are within the stock market index of some of these countries—a $500 million market cap can be quite meaningful in countries that have much smaller gross domestic product than that of the U.S.

I serve as the Portfolio Manager on this Fund, with Jenifer Taylor and Jim Harvey, serving as Assistant Portfolio Managers. Both have a lot of experience in the industry and in investing in international stocks in particular. Jen is the Portfolio Manager of this Fund's American cousin, Royce Micro-Cap Fund, which had 24.6% of its assets invested in non-U.S. stocks at the end of 2010. Jim is the Portfolio Manager of Royce Heritage Fund with Chuck Royce and Royce Select Fund II, both of which had almost a quarter of their assets invested in non-U.S. stocks at the end of last year.

Royce Global Dividend Value Fund [RGVDX] is a compelling opportunity as well. Probably the two most important themes in equity investing these days are global companies and dividends. We see each theme remaining timely for the foreseeable future. We think this portfolio comes together very nicely because most of the non-U.S. companies that we meet with pay a dividend, which is something we are not necessarily accustomed to as investors in domestic small-cap stocks. U.S. investors have been taught to believe that one must choose either growth or dividends. However, once you get outside of the U.S., the norm is "growth plus dividends." It's not uncommon for non-U.S. small cap companies to be at an earlier stage of their corporate evolution, so a lot of them are family owned, or family controlled, and typically the people running the company want the dividend stream—that's their source of income. 

Chuck Royce manages this Fund, and I work with Chuck as Assistant Portfolio Manager.

With such a large investable universe, how do you sift through all those stocks and decide what to select for each of the portfolios?

When investing in non-U.S. companies, Royce seeks the same attributes that we look for in domestic companies—strong balance sheets, an established record of earnings, the ability to generate free cash flow and excellent growth prospects.

Beyond that, we have developed a methodical and proactive approach for assessing companies as we meet with management teams and examine the balance sheets to help us avoid some of the common pitfalls of investing. For example, we want to avoid falling in love with a stock and being in denial as it loses one or more of the reasons we bought it, allowing familiarity to morph into conviction, or being too swayed by management's "story" and presentation.

We've established a scoring system to summarize our "Enterprise Conviction" level in companies we evaluate. This score is meant to isolate our assessment of quality, deliberately separating this from valuation. It's a system designed to bring greater consistency to the process of evaluating companies. The truth of the matter is that evaluation is always driven by some combination of science and art; ultimately, it is of course our judgment that matters.

It has served us well in domestic markets, as well as abroad. If a company has both a high enterprise conviction score and an attractive valuation, we are probably quite interested in that stock.

Read more about Royce's thinking on Enterprise Conviction.

Where are you finding exciting opportunities abroad?

Our investment themes in the non-U.S. markets shift every 12 – 18 months or so. Not so long ago, Royce's European approach was focused on the developed markets—Germany, Nordic Europe, the UK, and France, to a certain extent. While those markets are performing very well, things have also gotten very expensive, so these days we are scouring PIGS (Portugal, Italy, Greece and Spain) in Europe because we are finding great valuations there.

How is the Royce methodology distinctive in non-US markets?

We are looking for very different things than most non-U.S. small-cap investors. In Europe, for example, they tend to like "stories," whereas we are not so into stories: we are much more into businesses. They like turnarounds, and we'd prefer good quality companies that maybe had an earnings miss. And they like "blue sky" situations, zero-to-a-billion opportunities that are totally unproven. Outside of the U.S., investors often chase these three types of situations, which we don't really touch. So there is less competition for the things we focus on.

Also, we have a long-term investment horizon, with an average holding period of two to four years, which is not common among foreign investors.

Individuals outside the U.S. tend not to own as much stock as individuals here at home. Also, at the institutional level, there is not a lot of interest in investing solely or mostly in micro-cap or small-cap stocks. Finally, investment horizons outside the U.S. tend to be shorter because they are often investing in small and micro-cap companies for tactical reasons.

*Portfolio Approach

Diversified: A diversified portfolio at Royce is one that generally holds more than 100 securities and whose top positions generally do not exceed 2% of net assets.

Limited: A limited portfolio at Royce is one that either (i) generally invests in no more than 100 companies and whose top positions generally exceed 2% of net assets, or (ii) invests primarily in a single sector.