Royce Heritage Fund Manager Commentary | Royce Funds
article 06-30-2015

Royce Heritage Fund Manager Commentary

Our focus remains on companies that are poised for profit margin expansion as their revenue growth normalizes in concert with a fastermoving U.S. economy.


Fund Performance

Royce Heritage Fund was up 1.1% for the year-to-date period ended June 30, 2015, trailing its small-cap benchmark, the Russell 2000 Index, which gained 4.8% for the same period. The year began on a difficult note for most equities, with the major indexes all trending downward during January. It was tougher on small-caps than on mid- and large-cap issues, though losses were mitigated in large part by a stronger rebound for the Russell 2000 during the recovery for share prices during February and March.

The Fund performed in line with this pattern, struggling in January before coming back in the next two months, though its results were not as strong. For the first quarter, Heritage gained 1.2% versus a gain of 4.3% for the small-cap index. The second quarter had a pattern that was similar to that of the first—a bearish April was followed by mostly rising stock prices in May and June—but results were generally more muted. There was also the uncertainty, and resulting volatility, surrounding Greek debt that rocked the global equity markets at the very end of June and substantially tamped down second-quarter gains. Heritage defied the bearish trend in April but was unable to keep pace in the more growth-driven May and more tumultuous June. The Fund fell 0.1% for the second quarter compared to a 0.4% gain for the Russell 2000. Longer-term results were better on both an absolute and relative basis. Heritage beat the Russell 2000 for the 10-, 15-year, and since inception (12/27/95) periods ended June 30, 2015. The Fund's average annual total return since inception was 12.9%. We remain proud of the Fund's nearly 20-year record.

What Worked... And What Didn't

On a relative basis, two sectors had a significant negative impact for the semiannual period. Health Care was the clear leader within the small-cap market as a whole, driven by highly impressive results for biotech stocks. The Fund was significantly underweight this sector and had very limited exposure to biotech companies, which hurt relative performance. While Heritage was substantially overweight in Information Technology during the first half, it was also significantly underweight in software companies, which dominated overall technology returns in a fashion similar to what biotech did in Health Care.

Seven of the Fund's nine equity sectors posted net gains for the semiannual period, with Financials leading by a sizable margin. The portfolio was underweight in Financials compared to its benchmark, but easily compensated with effective stock selection—its sector holdings posted an overall better return than did those in the Russell 2000. The sector's results in the portfolio were propelled primarily by excellent results from holdings in the capital markets industry, which was home to five of Heritage's top-10 contributors in the first half. Value Partners Group is a Hong Kong-based asset manager with a value orientation that naturally appeals to us. Its stock often closely parallels movements in Hong Kong's and China's markets, which climbed precipitously into May before cooling off in June with the decline in Chinese stocks. We were pleased to see growth in its assets under management and improved performance and management fees, all of which helped its earnings. Shares of ManpowerGroup, which is in the Industrials sector, rose as demand for temporary staffing recovered in Europe, the company's largest revenue geography. It also experienced sturdy growth from its permanent placement segment, a high-margin end of its business. Finally, the firm announced two staffing acquisitions that expanded or solidified its status in Europe and the Australasia region and gave a hefty 63% boost to its dividend.

The Fund's largest detractor by a wide margin, Anixter International provides security systems and solutions, enterprise cabling, and also distributes electrical and electronic wire. The company's stock was hurt when Anixter reduced its organic growth outlook for the year in two of its core distribution businesses—the enterprise cabling and security solutions line and its electronic wire and cable segment. Other disadvantages included competitive pressures in cabling and security, slower U.S. industrial production due to the stronger dollar, and lower energy-related capital spending. Lower copper prices also remained a sales drag. Genesee & Wyoming owns and operates short line and regional freight railroads and provides related rail services through its subsidiaries. A newer position, its business was slowed primarily by a number of factors related to lower shipping traffic for steam coal, agricultural products, oil and frac sand, and metals.

Top Contributors to Performance
Year-to-Date Through 6/30/15 (%)1

Value Partners Group 0.58
ManpowerGroup 0.39
Cal-Maine Foods 0.30
SEI Investments 0.25
Clarkson 0.25
1 Includes dividends

Top Detractors from Performance
Year-to-Date Through 6/30/15 (%)2

Anixter International -0.33
Genesee & Wyoming Cl. A -0.19
Standard Motor Products -0.19
Medley Management Cl. A -0.17
Coronation Fund Managers -0.15
2 Net of dividends

Current Positioning and Outlook

After stalling briefly in the first quarter, the economy appears to have resumed a steady pace of growth that should benefit small-caps as a whole, particularly those in more economically sensitive areas of the market such as Industrials and Materials—two sectors in which the Fund was significantly overweight at the end of June. As such, our focus remains on companies that are poised for profit margin expansion as their revenue growth normalizes in concert with a fastermoving U.S. economy.

Average Annual Total Returns as of Quarter-End 6/30/15 (%)

Heritage -0.07 1.12 -2.85 12.03 11.57 8.64 9.05 12.86 12/27/1995
Russell 2000 0.42 4.75 6.49 17.81 17.08 8.40 7.50 8.78 N/A
Annual Operating Expenses: 1.51%

* Not Annualized

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

Important Performance, Expense, and Disclosure Information

All performance information in this piece 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 here. All performance and risk information reflects results of the Service Class (its oldest class). Operating expenses reflect the Fund’s total annual operating expenses for the Service Class as of the Fund’s most current prospectus and include management fees, 12b-1 distribution and service fees, other expenses, and acquired fund fees and expenses. Shares of RHF’s Consultant and R Classes bear an annual distribution expense that is higher than that of the Service Class. 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. Regarding the "Top Contributors" and "Top Detractors" 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 2015.

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, 2015, 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, 2015 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 generally invests a significant portion of its assets in 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’s broadly diversified portfolio does not ensure a profit or guarantee against loss. The Fund may invest up to 35% of its net assets in foreign securities (measured at the time of investment), 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 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.



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