Commentary

Whitney George and James "Chip" Skinner

While the Fund’s year-to-date performance is about flat, it outpaced the Russell 2000 Index by about 150 basis points (-0.36% vs. -1.81% as of May 31), and the long-term performance is even better. What portfolio positioning has worked well for the Fund this year?

Portfolio positioning, specifically two significant sector bets, have driven performance this year. First, we have only a modest exposure to the financial industry, about 7.5% of the portfolio, compared with more like 19% in the Russell 2000 Index, the Fund’s benchmark. Second, we have a substantial stake in the Natural Resources sector, about twice what the Index has, and that has served us well.

The oil and gas industry has been a positive contributor to performance. Unit Corporation, the Fund’s largest and best performing holding—has been through a two-year period of flattish drill activity, but recently we have signs that activity is picking up. Their un-utilized land drill rigs are being deployed, given that they are driven by more gas-oriented exploration activity and natural gas prices began to recover last summer after a tow year lull. With oil prices racing higher, gas has been trying to catch up and has recovered: oil is up 33%, and natural gas prices are up 50% so far this year. A lot of drilling activity tends to be driven by the commodity price. If they think they can make more money because prices are higher, the economics look better to drill a new rig. That’s what seems to be driving more activity. We are seeing the same trend in Canada, especially in the energy service companies that we are invested in, such as Trican Well Service and Ensign Energy Services.

Another Natural Resources holding that has served the portfolio well is Carbo Ceramics, which makes a drilling product called “proppants” which are tiny ceramic pellets. When you are drilling for gas or oil, you drill down and then push a charge, an explosive, down-hole, which fractures the rock horizontally. Drill fluids and proppants are then sent down to hold the crack open so that the oil/gas can flow up. Carbo Ceramics has benefitted from the increased drilling activity we are seeing. We have owned this company for some time, and increased our position late last year when it looked cheap, and we haven’t been sorry. Carbo Ceramics is the Fund’s second-best performer year-to-date.

Combined, Industrial Products and Industrial Services comprise about 25% of RVP’s Portfolio. What do you see that you like in the industrial sectors?

The weak dollar is actually helping industrial America by making our products cheaper. You are actually starting to hear about labor rates rising in places like China, and that also may be making U.S. production more attractive. Aside from automotive, which is plagued with consumer spending issues, industrial America is doing better than expected.

We have had some stock-picking success among industrial companies. MSC Industrial Direct, for example, has done quite well. They sell MRO (maintenance, repair and operations) products. Manufacturing plants all have a constant need for specific tools and replacement parts. MSC has a catalogue of these parts, with an extensive selection. They go in to companies and automate the ordering process, reducing both the amount of inventory needed on hand and staffing. We think it’s a great model. With the fear of recession and industrial slowdown a year or so ago, it got really cheap, so I added to our position, and it’s recovered well.

The scrap-metal industry is another success story in industrials. We own two scrap companies that have performed well: Schnitzer Steel Industries, and Sims Group, an Australian public company which acquired our holding Metal Management earlier this year. We liked the acquisition, and actually bought more after we met management of Sims Group. Schnitzer actually has three business lines: steel manufacturing, metals recycling, and now auto parts, a retail business which has sprung from its ownership of scrapyards. With scrap prices going through the roof, it’s been a good new emerging business line for them.

What areas have been disappointing from a performance standpoint?

Although the Natural Resources sector has performed well for RVP this year, some of our precious metals holdings have not (Silvercorp Metals and Silver Standard). Despite the fact that gold hit a peak of $1,000/ounce in mid-March, it’s about flat for the year-to-date. In fact, both gold and silver commodity prices have been volatile, and since we have 10-12% of RVP’s portfolio in precious metals companies, that’s hindered performance. We also own a couple of uranium companies, including Uranium Resources, which in particular detracted from performance. We continue to see potential from those companies, however, and continue to hold them in the portfolio.

What are the long-term trends you are following?

We are still bullish about our precious metals positions as a hedge to the declining dollar. And we are always trying to look out a couple of years…..eventually the country will come out of this slowdown, and the trick is to figure out which areas will come out first. We’ll continue to look at industrial companies. The trucking industry was hit hard early and is beginning to shake out. So that’s an area that’s been on our radar screen. Staffing companies is also an area that I think can bounce back. We are starting to look at retail areas with the thought that they may bounce back. On the other hand, commercial banks and consumer-related areas have certainly been punished, and I’m less confident about their recovery in the near term. There are so many challenges in the financial world triggered by the housing and mortgage crisis; a great number of banks may need to raise capital and some may go away altogether. I think that they have so much real estate exposure that it’s not likely that they will spring back to life any time soon.

Performance: Royce Value Plus Fund vs Russell 2000*

*Not annualized.

Important Performance Information

All performance information reflects past performance, is presented on a total return basis and reflects the reinvestment of distributions. 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 1% redemption fee payable to the Fund. Current performance may be higher or lower than performance quoted. Current month-end performance may be obtained by clicking here. Annual operating expenses reflect the Fund's total annual operating expenses for the Investment Class as of the Fund's most current prospectus and include management fees and other expenses. Shares of the Fund's Investment, Consultant, K and R Classes bear an annual distribution expense that is not borne by the Service Class.