Royce Low-Priced Stock Fund Manager Commentary
article 02-12-2018

Royce Low-Priced Stock Fund Manager Commentary

Leadership for growth stocks created challenges for the Fund in 2017.


Fund Performance

Royce Low-Priced Stock Fund increased 9.7% in 2017, trailing its small-cap benchmark, the Russell 2000 Index, which was up 14.6% for the same period. It was a relatively tough year for small-cap approaches that emphasize valuation and low share prices as large-caps beat small-caps, small-cap growth beat value, and small-caps beat micro-caps.

The strength of growth stocks was surprising in light of both the rebound for cyclical industries and value stocks in 2016 and the growing global economy, one in which we would typically expect these areas to excel.

What Worked… and What Didn’t

Six of the Fund’s 11 equity sectors made positive contributions to 2017 performance. Information Technology made by far the biggest positive impact, with Industrials and Financials also posting notable net gains. None of the sectors that detracted from results had a significant negative effect. The largest net losses came from Consumer Discretionary and Consumer Staples.

At the industry level, four groups stood out: electronic equipment, instruments & components, semiconductors & semiconductor equipment (both from Information Technology), metals & mining (Materials), and capital markets (Financials).

Two industries in Consumer Discretionary led the groups that detracted—specialty retail and multiline retail, which were followed by less impactful net losses for food products (Consumer Staples) and chemicals (Materials).

Relative to the Russell 2000, Consumer Discretionary, particularly the aforementioned specialty retail industry, accounted for a sizable share of the year’s underperformance. As highlighted by a number of the portfolio’s largest stock detractors discussed below, a combination of secular headwinds, compounded in some cases by company-specific operational shortfalls, proved a troublesome combination.

The Health Care sector was another significant source of underperformance as results were hampered by our low weighting as well as some stock selection missteps in biotechnology, one of the best-performing industries in the Russell 2000 in 2017. Stock picking also detracted in the large and diverse Industrials sector, most meaningfully in the professional services group.

Conversely, Financials were a major positive versus the benchmark, thanks to an underweight in banks, which were laggards in the small-cap index, and savvy stock selection in capital markets, where Ashmore Group, a U.K.-based specialist in emerging market fixed income, and alternative investment manager Hamilton Lane both enjoyed strong years.

Also helping relative results were stock selection in Energy (the only Russell 2000 sector to finish 2017 in the red), a combination of a higher weighting and effective stock selection in Information Technology, and lower exposure to Real Estate.

The Fund’s top contributor at the position level was Electro Scientific Industries, which manufactures laser and laser drilling systems, test and measurement equipment, and machine vision systems. An ongoing restructuring has significantly lowered break-even points, turning the company around to solid operating profits. We held some shares after taking gains as we see the firm remaining in growth mode.

Kirkland Lake Gold is a precious metals exploration and production company with assets in Canada and Australia. The company’s shares benefited from better-than-expected production results at its two main properties along with a relatively benign gold price environment. We held a respectably sized stake at the end of 2017 as the company is well financed and profitable, which we think positioned it to further exploit its key mining properties.

We moved on from BioAmber, an industrial biotechnology company that specializes in renewable feedstocks, because of our concerns with start-up issues in a first-of-its-kind fermentation plant and the company’s tight capital structure. Shares of value-priced department store operator Stein Mart were hurt, like those of many retailers, by ongoing sales pressure wrought by the growth of e-commerce, formidable enough challenges that were exacerbated by a series of internal merchandising missteps.

Our ongoing concerns about the secular shift to online shopping led us to sell our position in September. We also sold our shares of Ascena Retail Group, which acts as a holding company for a number of mostly women’s apparel retailers, including Ann Taylor, Dress Barn, and Justice. Its shares have been hurt by a combination of the online shift and internal operating miscues.

Top Contributors to Performance 20171 (%)

Electro Scientific Industries0.96
Kirkland Lake Gold0.76
IXYS Corporation0.59

1 Includes dividends

Top Detractors from Performance 20172 (%)

Stein Mart-0.59
Ascena Retail Group-0.50
J.C. Penney Company-0.46
Unique Fabricating-0.42

2 Net of dividends

Current Positioning and Outlook

We remain generally constructive on the U.S. economy, with tax reform likely to add a favorable tailwind to underlying earnings growth for many cyclical areas in 2018. Our largest weightings at the end of December remained Information Technology, Industrials, and Consumer Discretionary. Along with Energy, these large and diverse cyclical sectors were also our largest overweights versus the Russell 2000.

Within the disappointing specialty retail group, our rationale for larger exposure was a combination of intriguingly low valuations with select companies adopting effective omni-channel strategies that we anticipate should help them to emerge as stronger players following the current shakeout in the industry.

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

Low-Priced Stock 2.569.679.674.484.473.687.928.8110.07 12/15/93

Annual Operating Expenses: Gross 1.61 Net 1.58

1 Not annualized.

Important Performance, Expense, 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 total gross annual operating expenses and include management 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 Investment 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 1.24% through April 30, 2018. 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.

All performance and risk information presented in this material prior to the commencement date of Investment Class shares on 3/15/07 reflects Service Class results. Shares of the Fund's Service Class bear an annual distribution expense that is not borne by the Investment Class.

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: Ashmore Group was 0.9%, Hamilton Lane Cl. A was 0.9%, Kirkland Lake Gold was 0.8%, Electro Scientific Industries was 0.7%, QuinStreet was 0.7%, Novanta was 0.7%, Unique Fabricating was 0.6%, IXYS Corporation was 0.0%, BioAmber was 0.0%, Stein Mart was 0.0%, Ascena Retail Group was 0.0%, J.C. Penney Company 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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