article , video 08-18-2014

Current Opportunities in Consumer Discretionary

Poor holiday sales in 2013 and harsh winter weather have taken their toll on many Consumer Discretionary names so far in 2014. Portfolio Manager Charlie Dreifus tells Principal Dave Gruber why he's still attracted to the retail industry. 


Dave Gruber: One of the areas that you seem to have a fair amount of exposure to is Consumer Discretionary. That's been a pretty tough place to be in 2014. Talk to us about what you've been seeing there and what's attracted you to that sector.

Charlie Dreifus: The reason that I oft times own a lot of Consumer Discretionary, particularly retailers, is that one must remember, first of all, we are a consumption nation—70% of our GDP is internal consumption.

We do have really some great retailers around and, at times, their prices get beaten up in the market place. And that can come about because gasoline prices go up or heating prices go up—in a cold winter—or we have economic difficulties and the unemployment rate goes up.

So there are many factors that can give people hesitation and cause for concern regarding the sector. I'm, as you suggested, bottom up, so I look for anomalies: companies that appear to be mispriced.

Some of these Consumer Discretionary names that I bought I thought would do better than they ended up doing, and I didn't see light at the end of the tunnel. I don't pay for expectations, so I sold those losses. But the remaining names I stress test. I say to myself, well, how bad can this get? And in my valuation technique, in terms of the earnings number, I use the lower of the trailing 12-month earnings or future 12-month if they're lower.

Now in some of these retailers, despite the bearish stance of analysts, most of them had reasonably bullish earnings assumptions. So I said to myself, well, you know, if they're that concerned, these earnings, in my opinion, are too high. And so I take a lower level of earnings and say, would the stock still be attractive at that lower level of earnings? And the answer was yes.

But my small-cap fund, where we have 16 years plus of history here at Royce, has shown its defensive characteristics over that period of time. And I would argue that a large portion of that comes about because of that spread. The economic value, the fact that the cap rate—the return to the buyer—is higher than the cost of capital, that means that there's absolute value in this company, not only relative value.

A lot of people buy stocks that are inexpensive to the market or inexpensive to peers. That doesn't help much when the market's really in difficult times and sliding rapidly. It's only, in my experience, the ones that have the absolute value that really are selling below their economic worthiness that tend to do better during those market declines, and I would offer as some support for this notion our performance in the small-cap fund during those different periods of time.

Royce Special Equity Fund [RYSEX]
Average Annual Total Returns as of Quarter-End 6/30/14 (%)

Special Equity 0.93 0.16 15.27 13.21 16.16 8.61 11.23 10.03 5/1/1998
Russell 2000 2.05 3.19 23.64 14.57 20.21 8.70 8.01 7.13 N/A
Annual Operating Expenses: 1.13%

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.

Important Disclosure Information

The thoughts and opinions expressed in the video are solely those of the person speaking and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

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. Royce Special Equity Fund invests primarily in small-cap and micro-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) As of 6/30/14, the Fund held a limited number of stocks, which may involve considerably more risk than a less concentrated portfolio because a decline in the value of any one of these stocks would cause the Fund's overall value to decline to a greater degree.



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