article 06-30-2016

2016 Semiannual Manager Commentary for Royce Micro-Cap Fund

The ongoing effects of Brexit, our strange election season, and volatile commodity prices all notwithstanding, we remain cautiously constructive on the outlook for the U.S. economy. We have been researching and investing in micro-cap stocks for more than two decades and believe that our experience in this asset class can be a differentiator as the markets also continue to normalize.

TELL US
WHAT YOU
THINK
articleImage

Fund Performance

Royce Micro-Cap Fund finished the year-to-date period ended June 30, 2016 with a loss of 0.7%, outperforming its benchmark, the Russell Microcap Index, which was down 1.7%, while trailing the small-cap Russell 2000 Index, which rose 2.2% for the same period.

The first half therefore offered a mixed bag of relative results in what was often a tumultuous period for small- and micro-cap stocks

The first quarter was encouraging in its marked leadership shift to small- and micro-cap value even as its sudden share price plunges made things challenging. The Fund held its value relatively better in this highly volatile period, losing 1.1% in the first quarter compared to respective declines of 5.4% and 1.5% for Russell’s micro- and small-cap indexes.

The second quarter, marked by a slow and steady recovery for equities both before and after the market-rocking Brexit vote, was less rewarding on a relative basis. The Fund was up 0.4% for the quarter versus a 4.0% gain for the Russell Microcap and a 3.8% advance for the Russell 2000.

Royce Micro-Cap outperformed the Russell 2000 for the 20-year and since inception (12/31/91) periods ended June 30, 2016. (Data for the Russell Microcap only goes back to June 30, 2000.) The Fund's average annual total return since inception was 10.4%.

What Worked... And What Didn't

Seven of the Fund's 10 equity sectors were in the black at the end of June, with the most significant contributors coming from Information Technology and Consumer Discretionary while Materials also made a solid contribution.

Three industry groups made impressive contributions to first-half results—electronic equipment, instruments & components, semiconductors & semiconductor equipment (both from Information Technology), and metals & mining (Materials).

That last industry was home to the portfolio's top performer for the semiannual period, Olympic Steel. A leading steel and metal distributor, the company benefited from both sharply higher steel prices and increasing volumes in its service centers. We exited our position in the second quarter as it exceeded our sell-price targets.

"The ongoing effects of Brexit, our strange election season, and volatile commodity prices all notwithstanding, we remain cautiously constructive on the outlook for the U.S. economy. We have been researching and investing in micro-cap stocks for more than two decades and believe that our experience in this asset class can be a differentiator as the markets also continue to normalize."

Taiwan's Silicon Motion Technology provides software-based controllers used in mobile storage media and multimedia systems on a chip. As the leading merchant supplier, the firm is gaining business from the ongoing replacement of hard disk drives (HDDs) by flash memory while also gaining significant market share. We held our shares as we see both the HDD replacement cycle and the company's market share gains as still in the early innings of growth.

On a sector basis, Health Care had the largest net losses in the first half, followed by Energy. Biotechnology and pharmaceuticals were the Fund's two biggest detracting industry groups and endured significant downturns within both the micro- and small-cap indexes.

Lipocine, among the Fund's loss-leading positions in the first half, is a specialty pharmaceuticals business whose stock was hurt by a delay in approval of its orally induced testosterone drug. While we are unsure about the ultimate approval of this drug, we cautiously added to our position in the first half based on Lipocine's strong pipeline and the fact that it was trading close to the value of cash on its balance sheet.

We also increased our stake in SeaChange International, which provides video on demand software to cable television and telecommunications operators. Its shares fell as its efforts to offer a similar turnkey video solution to over-the-top video providers such as Netflix are proving to be a longer-term project than we and other investors had originally anticipated, which resulted in an unexpected CEO change. However, we like its inexpensive valuation and long-term prospects for success.

We also liked the combination of inexpensive valuation and long-term prospects for Ardmore Shipping, which operates mostly oil-based chemical tankers. Although we see the tanker market as moving from oversupplied to undersupplied, the uncertain global economic picture has made the transition less smooth than we initially suspected.

On a relative basis, the Fund was rewarded for its significant underweight, as well as effective stock selection, in the Health Care sector as we had comparatively lower exposure to correcting biotechnology stocks. Savvy stock picking was a significant relative contributor in the aforementioned electronic equipment, instruments & components and semiconductors & semiconductor equipment industries. Conversely, relative results were hampered in the first half by our much lower exposure to Financials, particularly REITs, which did very well, as well as ineffective stock selection in the real estate management & development industry.


Top Contributors to Performance
Through 2016 (%)1

Olympic Steel 0.45
Silicon Motion Technology ADR 0.41
Pretium Resources 0.40
McEwen Mining 0.35
Fabrinet 0.34
1 Includes dividends

Top Detractors from Performance
Through 2016 (%)2

SeaChange International -0.46
Ardmore Shipping -0.44
Lipocine  -0.37
BioAmber -0.33
Gulf Island Fabrication -0.29
2 Net of dividends

Current Positioning and Outlook

Sector weightings remained largely unchanged from the end of 2015. The ongoing effects of Brexit, our strange election season, and volatile commodity prices all notwithstanding, we remain cautiously constructive on the outlook for the U.S. economy.

This is reflected in our overweight positions in Information Technology, Industrials, and Consumer Discretionary, where we have been finding an intriguing overlap of relatively solid fundamentals and attractive valuations.

We have also been selectively adding names in Health Care, as the biopharma segment has corrected, and select bank and other financial stocks as we wait—and wait—for the eventual normalization of interest rates.

We have been researching and investing in micro-cap stocks for more than two decades and believe that our experience in this asset class can be a differentiator as the markets also continue to normalize.

Average Annual Total Returns Through 6/30/16 (%)

  QTR 1YR 3YR 5YR 10YR 20YR SINCE
INCEPT.
DATE
Micro-Cap 0.36 -12.74 -0.97 -1.58 2.89 8.59 10.44 12/31/91
Russell Microcap 3.97 -12.06 5.95 8.20 4.31 N/A N/A N/A
Russell 2000 3.79 -6.73 7.09 8.35 6.20 7.613 9.13 N/A
Annual Operating Expenses: 1.50%

* 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 Investment Class (its oldest class). 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. Shares of RMC’s Service and Consultant Classes bear an annual distribution expense that is not borne by the Investment Class. 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 2016.

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, 2016, 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, 2016 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 6/30/16, Olympic Steel was 0.0% of the Fund’s net assets, Silicon Motion Technology was 0.7%, Lipocine was 0.2%, SeaChange International was 0.4%, and Ardmore Shipping was 0.7.

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 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. 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 Microcap Index includes 1,000 of the smallest securities in the small-cap Russell 2000 Index, along with the next smallest eligible securities as determined by Russell. 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.

Insights & News

Share:

Subscribe:

Sign Up

Follow: