Royce International Discovery Fund Manager Commentary
article 02-12-2018

Royce International Discovery Fund Manager Commentary

While the Fund trailed its benchmarks, the Russell 2000 Index, we were pleased with its absolute performance.

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Fund Performance

The Fund was up 27.7% in 2017 versus an advance of 30.5% for its benchmark, the Russell Global ex-U.S. Small Cap Index, for the same period. The year saw a continuation of the growth and momentum driven market that has characterized much of the last eight years for international small- and micro-cap stocks. In addition, the second half of 2017 proved more challenging than the first as this period accounted for all of the Fund’s relative underperformance. Much of this was keyed by relatively disappointing results for portfolio holdings in the Consumer Discretionary sector—the Fund’s largest and its most significant overweight—in the third and fourth quarter of 2017.

What Worked… and What Didn’t

Nine of the Fund’s 10 equity sectors made positive contributions to calendar-year performance. Information Technology and Industrials led by a considerable margin, while notable net gains on an absolute basis also came from Consumer Discretionary, Materials, and Real Estate. Energy was the only sector that detracted, but did so modestly.

At the industry level, four groups from three different sectors made the biggest positive contributions—IT services (Information Technology), professional services (Industrials), real estate management & development (Real Estate), and semiconductors & semiconductor equipment (also from Information Technology).

The impact of detractors at this level was comparably light, led by construction & engineering (Industrials), oil, gas & consumable fuels (Energy), and communications equipment (Information Technology). Relative to the Russell Global ex-U.S. Small Cap, the Fund was hurt most by ineffective stock selection in Consumer Discretionary, especially in the specialty retail and auto components industries, as well as by our cash position.

Conversely, savvy stock picks in both Real Estate and Industrials were sources of outperformance versus the benchmark. The countries with the largest positive impact were Japan, the United Kingdom, and South Korea while holdings from Greece and China detracted most.

The Fund’s top-contributing position was Conviviality, which is the largest liquor distributor in the U.K., where it also operates franchised off-license and convenience chain stores. Formed through a series of acquisitions that were completed in 2015-16, the company saw the anticipated synergies from the combination bear fruit as the year went on, lifting its stock price.

South Korea’s Koh Young Technology makes 3D measurement and inspection equipment that improves accuracy and reliability. Strong macro tailwinds from the technology sector combined with its own disruptive technology to produce solid earnings growth and stock price performance.

Japan’s Outsourcing provides those services for manufacturing companies. Its business benefited from a strengthening Japanese economy, which led to low rates of unemployment and strong demand for its services. Taiwan’s TCI saw increased sales for its nutritional supplements, including new products, result in impressive earnings growth.

The leading detractor at the position level was Canada’s AGT Food and Ingredients, an exporter of pulses—edible seeds—as well as rice, wheat, and other staples. The company’s key Indian market had higher-than-anticipated pulse output of its own, and thus stopped imports. We chose to sell our shares in November.

Earlier in 2017, we did the same with our position in Quintis, an Australian firm that manages and cultivates sandalwood forests to produce sandalwood oil products. The resignation of its CEO and co-founder in March created uncertainty over the pricing of its Chinese contracts, which exerted substantial downward pressure on its shares.

We also exited our position in construction company Raubex Group as continued political uncertainty in South Africa delayed bids for construction projects, a situation that did not appear close to being resolved at the end of 2017.


Top Contributors to Performance 20171 (%)

Conviviality0.98
Koh Young Technology0.97
Outsourcing0.86
TCI0.86
Nova Measuring Instruments0.77

1 Includes dividends

Top Detractors from Performance 20172 (%)

AGT Food and Ingredients-0.57
Quintis-0.42
Raubex Group-0.29
KT Skylife-0.26
Aegean Marine Petroleum Network-0.24

2 Net of dividends

Current Positioning and Outlook

Most global markets are currently sitting at record levels in nominal terms with strong gains over the past year. It seems unlikely that 2018 will see a repeat of this exceptional performance. However, as bottom-up investors, we continue to find stocks that are under the radar and believe our strategy can potentially generate strong absolute returns going forward.

In November 2017, the Board of Trustees of The Royce Fund approved a name and investment policy change and a contractual investment advisory fee rate reduction for the Fund that become effective as of February 1, 2018. These changes give the Fund a new non-fundamental investment policy requiring at least 80% of its net assets to be invested in stocks with market caps up to $5 billion. In light of this, the Fund’s name will be changed to Royce International Discovery Fund to better describe this new expanded market cap range.

While our investment objective and strategy will not be changing, we believe that the expanded market cap range will substantially broaden the opportunity set of investment ideas and allow for improved marketplace recognition and adoption for the Fund.

Average Annual Total Returns Through 12/31/17 (%)

QTR1 YTD1 1YR 3YR 5YR SINCE INCEPT. DATE
International Discovery 6.4027.7227.7210.379.324.84 12/31/10

Annual Operating Expenses: Gross 2.79 Net 1.44

1 Not annualized.

Important Performance and Disclosure Information

Important Performance and Expense Information

 

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, 2017, 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, 2017 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 12/31/17, the percentage of Fund assets was as follows: Conviviality was 1.1%, Koh Young Technology was 0.9%, Outsourcing was 0.5%, TCI was 0.9%, Nova Measuring Instruments was 0.4%, AGT Food and Ingredients was 0.0%, Quintis was 0.0%, Raubex Group was 0.0%, KT Skylife was 0.0%, Aegean Marine Petroleum Network was 0.0%.


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 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 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 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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