article 02-22-2016

Royce Special Equity Multi-Cap Fund Manager Commentary

Altogether, Charlie Dreifus and Steven McBoyle are happy to say, "Goodbye and good riddance" to 2015. It was a bad year for penny-pinchers and bargain hunters—growth stocks trounced value stocks. There have been times before when the market has not behaved in a businesslike fashion, but we are still in a free market, a capitalistic economy where the rules of business and economic reality ultimately prevail. They have no doubt about this.

TELL US
WHAT YOU
THINK
articleImage

Fund Performance

Royce Special Equity Multi-Cap Fund was down 13.6% in 2015, underperforming its large-cap benchmark, the Russell 1000 Index, which was up 0.9% for the same period. For the year-to-date period ended December 31, 2015, the Fund was down 3.1% versus an advance of 1.7% for the large-cap index, which was disproportionately led by non-earning, lowest ROE quintile, and non-yielding companies—none of which meet the standards we've established for our classic value approach.

During the widespread downturn that shook the markets in the third quarter, the Fund lost 11.2% versus the benchmark's 6.8% slide. Share prices recovered somewhat in the fourth quarter when the portfolio increased 0.9% while the Russell 1000 advanced 6.5%. The Fund's average annual total return for the identical five-year/since inception (12/31/10) period ended December 31, 2015 was 9.0%.

Altogether, we are happy to say, "Good bye and good riddance" to 2015. For the market overall, the year was a wild ride to nowhere. The S&P 500 averaged its highest number of intraday swings since 2008. Since February 2007 the cheapest stocks in the U.S. have lagged their more expensive counterparts by 2.6% annually, an eight-year and seven-month stretch of underperformance that is the longest losing streak on record going back to 1926.

Our approach was rejected by the market in favor of more expensive stocks. Indeed, it was a bad year for penny-pinchers and bargain hunters—growth stocks trounced value stocks. There have been times before when the market has not behaved in a businesslike fashion. We are used to this, having seen it several times during our career. Yet this felt different. Nonetheless, we are still in a free market, a capitalistic economy where the rules of business and economic reality ultimately prevail. We have no doubt about this.

What Worked... And What Didn't

Six of the Fund's seven equity sectors posted net losses in 2015, though none were as steep as those in Consumer Discretionary, which were more than quadrupled those of the portfolio's next-worse sector, Financials.

The bulk of the sector's losses came from the specialty retail industry, including two of the portfolio's five largest holdings: top-five holding Bed, Bath & Beyond, which operates stores that sell primarily domestics merchandise and home furnishings, and retailer The Gap, which we sold in October.

Stocks in the sector's multiline retail and media groups also fared poorly. Our only position in the first of these industries is department store retailer Nordstrom, which was our fourth-largest holding at year-end.

Within the media group, both entertainment content company Viacom and television and Internet business operator Scripps Networks Interactive disappointed. We held shares in each at the end of 2015. In Financials, the biggest detractor was Franklin Resources, which does business as Franklin Templeton Investments and provides investment advisory services to mutual fund, retirement, institutional, and separate accounts. We sold the last of our shares in December.

"Against the backdrop of tepid demand for equities, particularly from individual investors who have endured two major market declines in the past 15 years, wide-scale multiple expansion looks unlikely. In our view, this highlights the case for the kind of bottom up, granular security selection that has always distinguished our disciplined and contrarian approach."

Relative results were substantially hampered by stock selection in Consumer Discretionary. Ineffective stock selection hurt most in three industries—specialty retail, multiline retail, and media. The portfolio's capital markets holdings in Financials also detracted, as did stock selection in Information Technology and Industrials. Low exposure to Energy was a bright spot in calendar-year relative performance.

For positive developments on an absolute basis, two top-10 positions contributed meaningfully—software giant Microsoft Corporation and auto parts maker Lear Corporation.


Top Contributors to Performance
For 2015 (%)1

Microsoft Corporation 1.33
Lear Corporation 1.12
manpowerGroup 0.78
Quest Diagnostics 0.51
Raytheon Company  0.34
1 Includes dividends

Top Detractors from Performance
For 2015 (%)2

Bed Bath & Beyond  -2.54
Nordstrom  -2.11
Viacom Cl. B -2.06
Franklin Resources -1.34
The Gap  -1.29
2 Net of dividends

Current Positioning and Outlook

Consumption is doing well. A new phrase—secular rejuvenation—is being used to describe the improving consumer situation in the U.S. Real incomes, as well as expectations, have risen, and perhaps most important household formations have increased substantially and are expected to continue to rise. The 2016 economy also got a boost late in December when Congress increased spending and cut business taxes, a common occurrence ahead of elections. These actions could add 0.7% to U.S. GDP in 2016.

2015 offered a potent reminder of how humbling this business can be. We have always ordered pencils with erasers to account for our mistakes knowing that our process does not work in all markets—it is not the Rosetta Stone. However, against the backdrop of tepid demand for equities, particularly from individual investors who have endured two major market declines in the past 15 years, wide-scale multiple expansion looks unlikely.

In our view, this highlights the case for the kind of bottom up, granular security selection that has always distinguished our disciplined and contrarian approach. We are pleased with the high cap rates and returns on invested capital of our holdings. In our view this makes many of them feel like positive events waiting to happen.

We also believe 2015 was an outlier, a highly anomalous year for equity performance and so we see the potential for better times for disciplined contrarians like ourselves. At the end of 2015, we remained substantially overweight in Consumer Discretionary and Industrials, and had significant exposure to Information Technology. We held no positions in Consumer Staples, Energy, Financials, Telecommunication Services, or Utilities and had much lower exposure to Financials and Health Care.

Average Annual Total Returns Through 12/31/15 (%)

  QTR* 1YR 3YR 5YR SINCE
INCEPT.
DATE
Special Equity Multi-Cap 0.49 -13.40 -13.40 9.03 N/A 9.19 12/31/10
Russell 1000 6.50 0.92 0.92 15.01 8.34 12.44 N/A
Annual Operating Expenses: 0.97%
*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). Gross operating expenses reflect gross total annual operating expenses for the Service Class 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 the 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 reimbursements. All expense information is reported as of the Fund's most current prospectus. Royce & Associates has contractually agreed to waive fees and/or reimburse operating expenses to the extent necessary to maintain the Service Classes' 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 1.24% through April 30, 2016. 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 December 31, 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 December 31, 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.

As of 12/31/15, Bed Bath & Beyond was 5.7% of the Fund's net assets, The Gap was 0.0%, Nordstrom was 5.7%, Viacom was 4.3%, Scripps Networks Interactive was %, Franklin Resources was 0.0%,Microsoft Corporation was 5.3%, and Lear Corporation was 4.4%.

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 mid-cap and large-cap stocks. The Fund's investments in mid-cap stock may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund generally invests a significant portion of its assets in a limited number of stocks, which may involve considerably more risk than a more broadly diversified portfolio because a decline in the value of any of these stocks would cause the Fund’s overall value to decline to a greater degree. The Fund may invest up to 25% 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 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The S&P 500 is an index of U.S. large-cap stocks selected by Standard & Poor's based on market size, liquidity, and industry grouping, among other factors. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

Insights & News

Share:

Subscribe:

Sign Up

Follow: