Royce Pennsylvania Mutual Fund Manager Commentary
article 02-12-2018

Royce Pennsylvania Mutual Fund Manager Commentary

A second consecutive year of strong absolute and relative performance helped the Fund further solidify long-term advantages over the Russell 2000 Index.

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Fund Performance

With a second consecutive year of strong absolute and relative performance, our flagship Royce Pennsylvania Mutual Fund further solidified long-term advantages over its small-cap benchmark, the Russell 2000 Index, outperforming for the one-, 20-, 25-, 30-, and 35-year periods ended December 31, 2017. The Fund advanced 16.2% in 2017, ahead of the 14.6% gain for the Russell 2000.

The attributes that investors favored in 2017—growth stocks in industries such as biotechnology and highly leveraged companies most notably—presented headwinds for the Fund’s multi-discipline approach. However, Penn also enjoyed tailwinds later in the year in the form of renewed strength for cyclicals—particularly those with global exposure.

All in all, 2017 was a good year, but with its mix of leadership for growth stocks against the backdrop of an accelerating global economy, it was a strange one as well.

What Worked… and What Didn’t

Eight of the Fund’s 11 equity sectors made positive contributions to 2017 performance. The portfolio’s two largest sectors—Industrials and Information Technology—led by a wide margin, followed by solid net gains for Health Care, which led the Russell 2000, and Financials. Consumer Discretionary and Energy detracted, albeit modestly, while Telecommunication Services and Utilities, the Fund’s smallest sectors were essentially flat.

The best relative performance in 2017 came from Financials, where both our lighter weighting in banks and heavier investment in capital markets companies were additive against the benchmark. Savvy stock selection in Information Technology was also an important factor in 2017’s outperformance.

The largest relative sector detractor was Consumer Discretionary, where weak stock selection in specialty retail hurt most, while our lower exposure to Health Care also detracted due to the Fund’s significant underweight in biotechnology stocks, one of the top-performing small-cap industries in 2017.

At the industry level, the largest contributions on an absolute basis came from electronic equipment, instruments & components (Information Technology) and machinery (Industrials), each from one of the Fund’s leading sectors, while the largest detractors, specialty retail (Consumer Discretionary) and energy equipment & services (Energy), came from its two worst.

For many years, the portfolio has invested heavily in companies that increase productivity or otherwise help business operate faster, cheaper, and more effectively. This ‘picks and shovels’ approach often leads us to industrial and technology companies with very interesting—and in many cases ultimately profitable—niche businesses.

Over the last few years, there has been a significant amount of innovation in areas such as process automation, robotics, lasers, cloud storage, etc.—all of which need equipment, components, and related technology. This has led us to invest in several companies that specialize in process automation or other innovative ways that boost productivity.

Moreover, the long-term outlook for select companies in these areas looks very promising to us as the current global technology build-out continues. It was no surprise, then, that four of the portfolio’s five top-contributing stocks in 2017 were technology stocks and that the fifth came from the Industrials sector.

Few holdings exemplify our goal for these kinds of companies more than the Fund’s top contributor in 2017, laser diode and equipment maker Coherent, which also occupied the Fund’s top spot in 2016. Its stock climbed thanks to a record-setting fiscal 2017, which saw sales and earnings growth driven by increasing demand for ramped up OLED (organic light-emitting diode) capacity and service. We reduced our position as its shares rose.

Sun Hydraulics is an industrial technology company that develops and manufactures solutions for the hydraulics and electronics markets. Its shares rose on robust sales and earnings as well as management’s cautiously optimistic outlook that included raised revenue guidance.

As for positions that detracted, specialized industrial services business Team disappointed as certain expected operational synergies did not materialize. We reduced our position, though we think its exposure to the recovering energy industry can help its business to improve.

We also trimmed our stake in CIRCOR International, which makes an array of valves and related flow control products and services. Valve sales to the domestic land-based oil industry improved when the price of oil rallied in the second half of the year, but could not offset the sales declines to large offshore project customers where investments are only now showing signs of bottoming and pricing is intense.


Top Contributors to Performance 20171 (%)

Coherent0.83
Sun Hydraulics0.82
Cognex Corporation0.70
IPG Photonics0.70
HEICO Corporation0.50

1 Includes dividends

Top Detractors from Performance 20172 (%)

Team-0.33
CIRCOR International-0.29
Core-Mark Holding Company-0.26
Ethan Allen Interiors-0.24
Matrix Service-0.22

2 Net of dividends

Current Positioning and Outlook

Our outlook is mixed. While we are cautious about the prospects for small-cap returns as a whole, we are also optimistic about the portfolio’s return potential as it leans towards three factors that we believe will be rewarded going forward—economically sensitive cyclicals, global exposure, and—in many cases—high profitability. These are the select qualities that we anticipate will drive small-cap leadership. In this environment, we see the opportunity for the Fund to continue outperforming in the years ahead.

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

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR 30YR 40YR
Pennsylvania Mutual 4.0616.2416.24 9.20 11.83 7.77 10.92 9.93 11.20 13.01
Russell 2000 3.3414.6514.65 9.96 14.12 8.71 11.17 7.89 10.46 N/A

Annual Operating Expenses: 0.93

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, 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 it's investment 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, 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: Coherent was 0.7%, Sun Hydraulics was 2.0%, Cognex Corporation was 0.6%, IPG Photonics was 0.6%, HEICO Corporation was 1.0%, Team was 0.1%, CIRCOR International was 0.9%, Core-Mark Holding Company was 0.4%, Ethan Allen Interiors was 0.7%, Matrix Service 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 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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