Royce Global Financial Services Fund Manager Commentary
article 02-14-2019

Royce Global Financial Services Fund Manager Commentary

We think the normalizing market environment—with higher rated, increased volatility and lower small-cap returns—should be supportive of many of the Fund’s investments.


Fund Performance

Royce Global Financial Services Fund fell 13.4% in 2018, trailing both the Russell 2000 Index, which declined 11.0%, and the Russell 2500 Financial Services Indexes, which was down 9.1% for the same period. After returning more than 22% in 2017 (and outpacing both indexes in the process), a moderation in the Fund’s pace of gains in 2018 would not have been unexpected, though we were not anticipating such a sharp correction as the one we had in 2018, which pushed calendar-year returns for most equities into negative territory for the year. We were pleased, however, that the Fund held its value better than the small-cap index in the precipitous fourth-quarter downturn, down 15.3% versus a loss of 20.2% for the Russell 2000.

What Worked… And What Didn’t

The capital markets group was our largest weighting, comprising almost 50% of assets at year-end. Our holdings in this space constituted a mix of traditional and alternative asset management businesses, both domestic and international, that we think run differentiated franchises with the ability to grow their businesses in an increasingly volatile environment. The downturn, however, proved no respecter of franchise strength or profit potential, and led to disappointing performances from several holdings. The largest detractor was Jupiter Fund Management, a U.K. based asset manager whose shares fell earlier in the year due to concerns about ongoing investments in the business that will lead to cost increases in excess of revenue growth, along with continued fee declines and fund outflows. Its stock slipped further in the fourth quarter after the company reported larger-than-expected outflows. We held our position based on our belief that Jupiter is a well-managed franchise positioned for long-term growth.

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Two top-contributing holdings from 2017 underwent significant reversals and landed among the bottom five detractors for 2018. SEI Investments runs a diverse business that provides investment processing, investment management, and investment operations solutions to clients around the globe. With products and services knit into the operations of several customers, SEI has what we think is a strong niche that’s built for the long term. Concerns about future spending levels from its primary client base as well as a second-quarter earnings disappointment led investors to mostly avoid its stock through the first three quarters of 2018, before its shares slumped further during the downturn, along with most other companies associated with asset management. U.S. Global Investors is a specialty asset manager focused mostly on emerging markets, precious metals, and, more recently, digital currencies. Its shares surged in 2017 following its investment in a blockchain technology company, which led us to sell nearly half our position. This move proved prescient as its stock began to decline significantly in 2018 when the price of the highly volatile cryptocurrency Ethereum collapsed in March. Volatile precious metals prices and a quarterly loss reported in November then combined to keep U.S. Global’s stock price tumbling.

Virtu Financial made the biggest positive contribution to performance. Based in New York City, the firm uses its technology to act as a market maker and liquidity provider to the global financial markets. Virtu announced impressive first-quarter results in profits and earnings, thanks to increased volatility, high trading volumes, and better-than-expected progress integrating a large acquisition. We took some gains around this time, just as its shares began to slide. Its shares then advanced in the fourth quarter as its business model again benefited from increased volatility. In 2017, we added to our stake in Popular, one of the largest Puerto Rico-based banks, as its stock was lagging, so we were especially pleased to see it rebound from a difficult 2017 to become one of 2018’s top contributors. Strong earnings in 2018, along with an opportunistic, accretive acquisition, have led the stock to outperform, a happy exception to a poor year for most small-cap banks.

Top Contributors to Performance 20181 (%)

Virtu Financial Cl. A1.34
Financial Engines0.31
Bottomline Technologies0.27

1 Includes dividends

Top Detractors from Performance 20182 (%)

Jupiter Fund Management-0.75
SEI Investments-0.75
U.S. Global Investors Cl. A-0.74
Altus Group-0.64

2 Net of dividends

Current Positioning and Outlook

2018 marked another year in the march towards what we believe are normalizing markets. We see three components in this process: a more normally sloped yield curve, which is steeper than today; a more historically typical level of volatility, which is higher than investors have experienced, other than in 2018’s fourth quarter; and below average intermediate-term returns—we expect mid- to high-single digits for the small-cap index, compared with low double-digit historical returns. These changes in the market environment should be supportive of many of the Fund’s investments. Higher volatility has historically provided active managers more room to outperform while steeper yield curves are supportive for banks and other lenders. We remain constructive on bank holdings based on the belief that certain positions have excellent prospects for growth in their wealth management operations while others offer what we think is an attractively differentiated business model or a geographic franchise that we think will help subsequent growth. Equally important, low nominal returns should continue to support demand among institutional investors for alternative asset managers and among high net worth investors for wealth management services. We believe that the portfolio is therefore well positioned to benefit from the coming environment.

Average Annual Total Returns Through 12/31/18 (%)

Global Financial Services -15.33-13.41-13.416.193.3710.887.077.07 12/31/03

Annual Operating Expenses: Gross 1.77 Net 1.58

1 Not annualized.

Important Performance and Disclosure Information

Important Performance and Expense Information

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 Gross operating expenses reflect the Fund's 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. 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, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Service Class’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 1.49% through April 30, 2019. 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.

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

Notes to Performance and Other Important Information

The thoughts expressed in this report concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at December 31, 2018, 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, 2018 and are subject to change at any time without notice. There can be no assurance that securities mentioned in this report will be included in any Royce-managed portfolio in the future.

As of 12/31/18, the percentage of Fund assets was as follows: Virtu Financial Cl. A was 3.1%, Popular was 3.0%, Benefitfocus was 1.2%, Financial Engines was 0.0%, Bottomline Technologies was 1.2%, Jupiter Fund Management was 1.0%, SEI Investments was 1.9%, U.S. Global Investors Cl. A was 0.5%, Clarkson was 1.6%, Altus Group was 1.4%

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. 

All indexes referred to are unmanaged and capitalization weighted. Each index’s returns include net reinvested dividends and/or interest income. 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 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 Russell 2000 Value and Growth Indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The Russell 1000 Index is an 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 Russell Microcap Index includes 1,000 of the smallest securities in the Russell 2000 Index, along with the next smallest eligible securities as determined by Russell. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities in the Russell 1000 Index. The Russell Global ex-U.S. Small Cap Index is an index of global small-cap stocks, excluding the United States. The Russell Global ex-U.S. Large Cap Index is an index of global large-cap stocks, excluding the United States. The Russell 2500 is an unmanaged, capitalization-weighted index of the 2,500 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. Returns for the market indexes used in this report were based on information supplied to Royce by Russell Investments. Royce has not independently verified the above described information.

This material contains forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve risks and uncertainties, including, among others, statements as to: 

-the Funds’ future operating results,

-the prospects of the Funds’ portfolio companies,

-the impact of investments that the Funds have made or may make, the dependence of the Funds’ future success on the general economy and its impact on the companies and industries in which the Funds invest, and

-the ability of the Funds’ portfolio companies to achieve their objectives.

This discussion uses words such as “anticipates,” “believes,” “expects,” “future,” “intends,” and similar expressions to identify forward-looking statements. Actual results may differ materially from those projected in the forward-looking statements for any reason.

The Royce Funds have based the forward-looking statements included in this commentary on information available to us on the date of the commentary, and we assume no obligation to update any such forward-looking statements. Although The Royce Funds undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events, or otherwise, you are advised to consult any additional disclosures that we may make through future shareholder communications or reports.

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. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see ""Primary Risks for Fund Investors"" in the prospectus.)



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