article 11-20-2013

Royce Select Fund I: Valuation and Emerging Quality

Why is valuation so important to our investment and risk management process, and how does Royce Select Fund I Portfolio Manager Lauren Romeo determine if a potential investment has the ability to appreciate over time?


Royce Select Fund I is part of a suite of limited portfolios here at Royce that accentuate high quality and attractive valuation in the stock selection process. It marked 15 years of history on November 18, 2013.

The Fund invests primarily in micro-cap, small-cap, and mid-cap stocks with market capitalizations up to $5 billion. It also may invest in both long and short positions, though it has been a long-only portfolio throughout most of its history.

Portfolio Process

Typically investing in approximately 70 positions, the Fund is a relatively limited portfolio. Portfolio Manager Lauren Romeo looks for quality companies as characterized by:

  • A solid balance sheet
  • A history of high returns on capital
  • Strong free cash flow generation
  • A durable business model
  • Identifiable growth opportunities

Applying a rigorous fundamental research and analytical process, Lauren meets regularly with management teams not only with those representing companies of interest, but also their competitors, customers, suppliers, and other industry experts. The focus of this research includes understanding the economics of the companies’ business models, the competitive landscape, the companies’ growth strategies, and managements’ capital allocation priorities and incentive compensation metrics. 

Valuation is also a key component in our investment and risk management process. A great company will not necessarily be a great investment if we overpay. Lauren applies a disciplined value approach of buying companies when they are trading at a 30-50% discount to her estimate of their true worth. This margin of safety provides a measure of downside protection as the companies’ share prices are reflecting a lot of negative news and low expectations as compared to companies that are priced for perfection.

The opportunity to buy premier companies at our target valuation metrics often comes when the companies’ financial results are depressed due to cyclical factors or company-specific reasons. The goal is to buy companies when the perception about the nature of their struggles is worse than their financial or operational reality. As such, a key question we seek to answer through our research process is whether the negative issues are temporary and fixable such that the company will be able to return to normalized earnings power over time, or whether a structural change to the business has occurred such that prior attractive returns on capital will not be achieved going forward.

Lauren’s methodology also includes a search for “emerging quality.” These are companies that have the potential to boost their returns on invested capital to above-average levels due to a change in either their industry’s structure—consolidation leading to a more rational competitive environment, for example—or at the company level, such as a new management team, divestiture of an underperforming asset, or exiting an unprofitable line of business.

Lauren first became involved with the Fund by serving as its assistant portfolio manager from 2005 to 2006. She went on to co-manage the Fund with President and Co-Chief Investment Officer Chuck Royce from 2006 to 2009, and became the Fund’s primary portfolio manager in 2009. Chuck Royce helmed the portfolio at its inception in November 1998. He then served as co-manager with Lauren from 2006 to 2009 and became assistant portfolio manager in 2009.

Rolling on with Rolling Returns

Royce Select Fund I [RYSFX]
Average Annual Total Returns as of Quarter-End 9/30/13 (%)

  QTR YTD 1YR 3YR 5YR 10YR Since
Select I 8.56 15.86 22.79 12.90 10.34 11.62 13.79 11/18/1998
Russell 2000 10.21 27.69 30.06 18.29 11.15 9.64 8.44 N/A
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Royce Select Fund I [RYSFX]
Average Annual Total Returns as of Month-End 10/31/13 (%)

  OCT YTD 1YR 3YR 5YR 10YR Since
Select I 2.98 19.31 25.07 13.10 16.16 11.07 13.93 11/18/1998
Russell 2000 2.51 30.90 36.28 17.69 17.04 9.03 8.57 N/A
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Annual Operating Expenses: 1.15%

Important Performance and Expense Information

All performance information 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 1% redemption fee, payable to the Fund, which is not reflected in the performance shown above; if it were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained here. 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.

Effective May 1, 2015 Royce Select Fund I will be closed to all purchases and exchanges into the Fund.

Monthly Rolling Average Annual Return Periods
Since Fund Inception through September 30, 2013

  Periods Beating
the Index (%)
Fund AVG (%)1 Index AVG (%)1
100 11.6 6.1
96 11.6 6.1
85 12.2 6.9
66 14.2 9.4

1 Average return shown is the average of all month-end trailing one-, three-, five-, and 10-year total returns.

We have been pleased with the Fund’s long-term results on an absolute basis. While on a relative scale the Fund has underperformed of late, its results in monthly rolling return periods have been terrific. On a monthly basis, the Fund outperformed the Russell 2000 in 100% of all 10-year periods, 96% of all five-year periods, 85% of all three-year periods, and 66% of all one-year periods.

For 100% of the periods, the Fund’s 10-year average annual total returns were greater than 5%, and for 93% of the periods, 10-year average annual total returns were greater than 10%.

Important Disclosure Information

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. The Fund invests primarily in micro-cap, small-cap, and mid-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund may sell securities short which involves selling a security it does not own in anticipation that the security's price will decline. Short sales present unlimited risk on an individual stock basis since the Fund may be required to buy the security sold short at a time when the security has appreciated in value. The Fund also invests primarily in a limited number of stocks, which may involve considerably more risk than a less concentrated portfolio because a decline in the value of these stocks would cause the Fund's overall value to decline to a greater degree. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund may invest up to 15% of its net assets in foreign securities, which may involve political, economic, currency, and other risks not encountered in U.S. investments. (Please see "Investing in Foreign Securities" in the prospectus.) 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 2000 is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 index. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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