Royce Opportunity Fund Manager Commentary
article 02-14-2019

Royce Opportunity Fund Manager Commentary

Our small-cap deep value approach weathered the 2018 bear market, and the Fund beat its benchmarks, the Russell 2000 and Russell 2000 Value Indexes, for the three-, 10-, 20-year, and since inception (11/19/96) periods ended 12/31/18.

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Fund Performance

The bear market that emerged late in the year failed to deter Royce Opportunity Fund’s longer-term relative advantages. The Fund was down 20.0% in 2018 compared to respective declines of 11.0% and 12.9% for its small-cap benchmarks, the Russell 2000 and Russell 2000 Value Indexes, for the same period. However, our consistent and time-tested deep value strategy allowed Opportunity to outpace both indexes for the three-, 10-, 20-year, and since inception (11/19/96) periods ended December 31, 2018 while also beating the Russell 2000 Value for the 15-year period. Just as we were disappointed by the Fund losing more than its benchmark in 2018, we are similarly confident that its long history of robust rebounds in market recoveries can continue.

What Worked… And What Didn’t

We have historically invested most heavily in cyclical areas, including technology, industrials, and manufacturing materials. The bulk of our holdings in these areas, particularly in the industrial space, were executing effectively early in 2018, with many reporting earnings strength consistent with the fast pace of U.S. economic growth. By late summer, however, tariffs, trade war worries and falling oil prices coincided to raise suspicions that these cyclical businesses would be unable to maintain their strengths. A slowing global economy only served to exacerbate these fears. So while a number of our companies continued to report attractive results, investors grew, if anything, increasingly unconvinced, as evidenced by the dramatic decline that shook the markets in 2018’s fourth quarter.


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Unsurprisingly, then, Industrials detracted most by a wide margin in 2018, followed by net losses for Energy, Health Care, and Consumer Discretionary. The only two portfolio sectors to finish 2018 in the black were Communication Services and Utilities. Machinery (Industrials) was the largest detractor at the industry level by a wide margin, followed by oil, gas, & consumable fuels and energy equipment & services (both from Energy), and health care providers & services (Health Care). The biggest positive contributors were hotels, restaurants & leisure (Consumer Discretionary) and consumer finance (Financials). Invacare Corporation, which manufactures health care products to the global non-acute care market, detracted most at the position level. While its European markets remain solid, sales have been sluggish elsewhere, hurt by tariffs, increased freight expenses, and higher commodity and material costs. We built our stake in 2018, as we did with United Natural Foods, the largest wholesale distributor to the natural, organic, and specialty foods industry in the U.S. and Canada. Rising prices have pressured earnings, but we have confidence in the strength of its franchise.

Relative to the Russell 2000, stock selection hurt calendar-year relative results most, with sector allocation having a much smaller negative effect. The largest negative impact versus the benchmark came from Industrials— the result of poor stock selection and our overweight—while ineffective stock picks and our underweight in Health Care hurt nearly as much. Machinery companies Westport Fuel Systems, which manufactures and supplies alternative fuel systems and components, and NN, which makes high-precision components and assemblies, struggled most due to earnings disappointments while several holdings in health care providers & services endured heightened competition that dampened revenue and earnings.

The biggest relative advantage in 2018 came from savvy stock selection in Financials, where holdings in the consumer finance and, to a lesser extent, capital markets industries drove results. Enova International stood out in consumer finance, and in the overall portfolio, due to the comparative resilience of its stock price between September and December. Enova is a payday lender that’s been expanding its roster of offerings to include installment loans and lines of credit that are not subject to banking regulations. The portfolio’s cash position was an additional net positive versus the Russell 2000 in 2018.


Top Contributors to Performance 20181 (%)

Enova International0.43
Fabrinet0.41
Belmond Cl. A0.35
Ciena Corporation0.34
SUPERVALU0.32

1 Includes dividends

Top Detractors from Performance 20182 (%)

Invacare Corporation-0.66
United Natural Foods-0.62
Westport Fuel Systems-0.55
NN-0.55
Herc Holdings-0.51

2 Net of dividends

Current Positioning and Outlook

We are guardedly optimistic about the ongoing health of the U.S. economy and the potentially positive effect that this could have on cyclical industries going forward, especially with stock prices falling to such low levels in December. A slower pace in U.S. growth is very different from a recession. To us, a slower growth rate following peak levels is also part of the typical ebb and flow of any healthy economic cycle. So while headwinds are undoubtedly present in the form of tariffs, anemic global growth, contracting liquidity, and the risk of recession, we have enough positive information from companies and on the industry level to indicate that slower growth seems more likely in 2019 than recession. Small-cap stocks generally looked relatively inexpensive at the end of 2018, but we are focused as much on potential drivers of growth as we are on price. As such, we have been diligent and discriminating buyers, looking for what we see as the most promising combination of attractively low valuations and potential earnings growth, especially for companies that the market seems to have all but abandoned. This has led us to investments in businesses involved in areas such as infrastructure, housing, healthcare services, and select areas within the industrial and technology spaces.

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

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Opportunity -24.05-19.97-19.978.201.7313.737.1410.6110.98 11/19/96

Annual Operating Expenses: 1.20

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 www.roycefunds.com. 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 and other expenses.

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: Enova International was 0.0%, Fabrinet was 0.7%, Belmond Cl. A was 0.0%, Ciena Corporation was 0.8%, SUPERVALU was 0.0%, Invacare Corporation was 0.4%, United Natural Foods was 0.3%, Westport Fuel Systems was 0.4%, NN was 0.5%, Herc Holdings was 0.7%


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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