article 06-30-2014

Royce International Smaller-Companies Fund Manager Commentary

Non-U.S. small-cap indexes frequently trailed their domestic peers over the last several years. This was somewhat rectified by a stronger first half for many international small-cap companies. Royce International Smaller-Companies Fund advanced 6.6% for the year-to-date period ended June 30, 2014, trailing its benchmark, the Russell Global ex-U.S. Small Cap Index, which rose 7.5% for the same period. We were satisfied with the Fund’s first-half results on an absolute basis.

Small-caps outside the U.S. enjoyed fine results in 2013, though they finished the year well shy of the heady returns for U.S. small-caps. Returns for both U.S. and non-U.S. smallcaps were lower in 2014’s opening quarter, though international small-cap performance was stronger in general. For the first quarter, the Fund was up 2.3% versus a gain of 3.2% for the international small-cap index. Equity performance throughout Europe remained mostly robust in the year’s opening quarter, though many Asian markets corrected and a number of the Fund’s holdings based in Hong Kong, Japan, and South Korea endured a bearish first quarter while holdings in India and China were on the whole positive contributors. Holdings in Germany, Cyprus, and South Africa also endured a difficult first quarter.

The second quarter saw Europe slow a bit (the Russell European Small Cap Index fell 1.0%) while there were solid recoveries in many parts of Asia. The Fund essentially tied its benchmark for the quarter, each up 4.2%. Holdings in India remained strong to the point of near dominance, while several Japanese companies rebounded to post a strong net contribution from that nation in the portfolio. Holdings in China, France, and Belgium led the list of detractors based on country. We remain disappointed with the Fund’s intermediate and long-term relative results. We were pleased, however, to see International Smaller-Cos outpace the Russell Global ex-U.S. Small Cap for the since inception (6/30/08) period ended June 30, 2014.

Each of the Fund’s nine equity sectors finished the first half in the black, with Industrials leading and Health Care, Materials, and Consumer Discretionary also showing strength.

Three Indian companies were among the portfolio’s top five contributors, each benefiting from the May election of Prime Minister Narenda Modi, who won a rare single-party majority that gave his party a mandate for a more pro-business, anti-bureaucracy direction. FAG Bearings India is one of the two key foreign-linked ball-bearings manufacturers in India. We like its strong balance sheet and rising profits, though we reduced our position as its stock price climbed. AIA Engineering makes grinding balls used in mining and in the production of cement. Its fiscal fourth-quarter results, reported in late May, showed a significant increase in after-tax profit year-over-year that was driven by margin expansion, as its mining business showed the benefits of scale. We took some gains in the second quarter. Shriram Transport Finance is the leading lender to the used-truck market, a play on higher freight rates and an overall improved business climate in India. Its shares had been slowed by regulatory changes and India’s economic slump. The influential local broker Edelweiss initiated coverage on the company with a buy rating in June, giving its stock price a boost. All three companies are considered “NaMo” stocks—economically sensitive, pro-cyclical businesses that are expected to flourish under the administration of the new prime minister. Italian company De’Longhi manufactures a wide variety of small appliances, including coffee makers, electric ovens, kettles, toasters, and food processors. Rising revenues and solid earnings kept investors interested.

Net losses were mostly modest at the industry and position level. Pico Far East Holdings is a Hong Kong-based business that makes displays for companies presenting at conventions and creates other visual identity solutions for clients such as Mercedes Benz, Lexus, Citibank, and Singapore Airlines. We like the way that its management keeps a close eye on costs and runs a lean organization. Its business was hurt by the slowdown in the Chinese economy, which prompted us to build our position throughout the first half. A softening rubber price had a predictably negative effect on the stock price of Societé Internationale de Plantations d’Heveas, a French firm that produces natural rubber and operates rubber tree plantations in French-speaking Africa. We added shares as its price fell. Brasil Brokers Participacoes is one of Brazil’s two leading real estate brokerages. Its business has been hurt by poor consumer sentiment (the worst since 2008) and possibly some modest erosion in market share. We built our stake during the first half. One Brazilian company, however, bucked that nation’s bearish trend and enjoyed success in the first half. CETIP-Mercados Organizados organizes the over-the-counter (OTC) markets in Brazil. The company offers an electronic platform for conducting online transactions, such as auctions and government bond trading, corporate bonds, and fixed income securities. CETIP also provides central securities depository, outsourcing, market data, and risk management services. Its shares rose on what we suspect was a flight to company quality in Brazil’s first-half bear market.


GOOD IDEAS THAT WORKED
Top Contributors to Performance
Year-to-Date through 6/30/14
1

FAG Bearings India 0.57
CETIP - Mercados Organizados 0.52
AIA Engineering 0.47
Shriram Transport Finance 0.46
De'Longhi 0.44
1 Includes dividends

GOOD IDEAS AT THE TIME
Top Detractors from Performance
Year-to-Date through 6/30/14
1

Pico Far East Holdings -0.43
Societe Internationale de Plantations d'Heveas -0.36
Brasil Brokers Participacoes -0.33
New World Department Store China -0.33
Globaltrans Investment GDR -0.30
1 Net of dividends

Average Annual Total Returns as of Quarter-End 6/30/14 (%)

  QTR YTD 1YR 3YR 5YR SINCE
INCEPTION
INCEPTION
DATE
 
International Smaller-Cos 4.24 6.59 21.02 4.04 13.15 7.56 6/30/2008
Russell Glo x US SC 4.20 7.54 23.86 6.52 13.88 5.36 N/A
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Annual Operating Expenses: Gross 2.08% Net 1.7%

Current month-end performance may be obtained from our Prices and Performance page.

Important Disclosure Information

All performance information in this Report 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 2% 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. Gross operating expenses reflect total gross annual operating expenses and include management fees, 12b-1 distribution and service 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 any applicable Fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund’s most current prospectus. Royce & Associates has contractually agreed to waive its fees and/or reimburse operating expenses to the extent necessary to maintain the Fund’s net annual operating expenses, (excluding brokerage commissions, taxes, interest litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business), at or below 1.69% through April 30, 2015 and at or below 1.99% through April 30, 2024. Regarding the two “Good Ideas” tables shown above, the sum of all contributors to, and all detractors from, performance for all securities in the portfolio would approximate the Fund’s year-to-date performance for 2014.

The thoughts expressed in this piece concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at June 30, 2014, and, of course, historical market trends are not necessarily indicative of future market movements. Statements regarding the future prospects for particular securities held in the Funds' portfolios and Royce's investment intentions with respect to those securities reflect Royce's opinions as of June 30, 2014 and are subject to change at any time without notice. There can be no assurance that securities mentioned above will be included in any Royce-managed portfolio in the future.

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 may invest a significant portion of its assets in foreign companies, which may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic, or other developments that are unique to a particular country or region. (Please see "Investing in Foreign Securities" in the prospectus.) Therefore, the prices of the securities of foreign companies in particular countries or regions may, at times, move in a different direction than those of the securities of U.S. companies. (Please see "Primary Risks for Fund Investors" in the prospectus.) In addition, 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. The Fund invests primarily in small-cap and/or 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.) 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 Global ex-U.S. Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks, excluding the United States. Index returns include net reinvested dividends and/or interest income. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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