Portfolio Allocation Brief: Royce Opportunity In Different Market Regimes
article , video 09-04-2018

Portfolio Allocation Brief: Royce Opportunity In Different Market Regimes

Senior Investment Strategist Steve Lipper discusses performance trends for Royce’s Deep Value Strategy.

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How would you describe Royce’s Deep Value Strategy to an asset allocator?

So we characterize the Royce Opportunity Strategy as a deep value strategy. Why do we do that? Well, valuation is really at the core of the discipline, in that they, they look for stocks that are cheap based on price-to-book and price-to-sales. Actually distinctively cheap. Generally, 25 to 30% cheaper than the overall market. You know, that creates a portfolio that has a number of attributes. The first is, it has high active share. So it regularly is 90 or above active share portfolio. The second is, a distinctive portfolio has the opportunity for distinctive performance. And this strategy has a history of that. Over 70% of the rolling five-year periods, the strategy has beaten the Russell 2000.

How has the Fund performed in single digit market environments?

We think that’s a particularly relevant question because at Royce we believe we are transitioning from a period where the small-cap index, the asset class itself, gave you double digit returns, to a period which is probably more likely to be single digit. Let’s look at Opportunity Strategy and how it has executed in those different environments.

Monthly Rolling 5-Year Average Excess Returns
Opportunity Minus Russell 2000 from 11/30/96 through 6/30/18

Monthly Rolling 5-Year Average Excess Returns

Russell 2000 Five-Year Return Range

Well, the history is that the greatest spread on rolling five-year basis that Opportunity Strategy has had has actually been in single digit return environments for the Russell 2000. More precisely when returns have been on a five-year basis between 5 and 10% for the Russell, that has been actually the best spread period for the Opportunity Strategy. Why is that relevant now? Well, we think the most likely scenario for the next five years is that high single digit return for small-caps, and historically that’s been really good for this strategy.

How has the strategy historically done in rising interest rate environments?

We think perhaps among the most underappreciated attributes of the Royce Opportunity Strategy is how well it has historically done in rising interest rate environments.

When 10-Year Treasury Yield was Rising, Opportunity Outperformed the Russell 2000
Trailing Monthly Rolling 1-Year Returns (11/30/96-6/30/18)

batting average 10-Year Treasury Yield average 1-year return 10-Year Treasury Yield

The performance data and trends outlined in this video are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

So if you look one year periods where the 10-year treasury yield has risen over the course of that period, and you said, “How did Opportunity Strategy do versus the small-cap index,” the striking result is over 90% of those periods Opportunity beat the Russell 2000 and by an average of over 1,100 basis points. So rising interest rate environments, if that’s what an allocator thinks is coming, this strategy has historically done quite well.

What is the case for investing in Opportunity strategy today?

So a reasonable question may be well, markets are at all-time highs, you probably are having a hard time finding attractive investments. Maybe this isn’t the best time for this strategy. So that perspective, we think reveals what we think is an enduring misunderstanding about the small-cap market. So one of the things that we feel is perennially underappreciated about the small-cap market is that cliché that it’s, it’s not a stock market, it’s a market of stocks. And what we mean by that is there is wide variation in both quality and valuation at all times and that creates opportunity.

Many Small-Caps Sell at a Significant Discount
Bottom Three Deciles in Russell 2000 Median
LTM EV/EBIT 1 ex negative EBIT as of 6/30/18

Bottom Three Deciles in Russell 2000 Median

1Last Twelve Months Enterprise Value/Earnings Before Interest and Taxes

If you look at the overall Russell 2000 and say what are the bottom three deciles on valuation, using enterprise value to earnings before interest and taxes as the valuation metric, what you find is there's a wide variation. That the bottom three deciles sell between a 28 to 57% discount to the overall market. The small-cap market is so wide and diverse that while still maintaining the valuation discipline, the Opportunity Strategy is always finding interesting investment candidates.

Important Disclosure Information

Average Annual Total Returns as of 6/30/18 (%) 

  QTR1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Opportunity 6.72 17.23 12.24 11.40 11.15 11.48 11.93 12.61 11/19/96
Russell 2000 7.75 17.57 10.96 12.46 10.60 10.50 8.03 8.90 N/A

Annual Operating Expenses: 1.18% 

1 Not annualized.

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 30 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 at www.roycefunds.com. 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, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies.

The thoughts and opinions expressed in the video are solely those of the persons speaking as of July 9, 2018 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.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The Russell 2000 Index 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.

Sector weightings are determined using the Global Industry Classification Standard ("GICS"). GICS was developed by, and is the exclusive property of, Standard & Poor's Financial Services LLC ("S&P") and MSCI Inc. ("MSCI"). GICS is the trademark of S&P and MSCI. "Global Industry Classification Standard (GICS)" and "GICS Direct" are service marks of S&P and MSCI.

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 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.) The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss.

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