Royce Premier Fund Manager Commentary
article 02-12-2018

Royce Premier Fund Manager Commentary

A second consecutive year of strong absolute and relative performance allowed the Fund to extend its relative advantages over the Russell 2000.


Fund Performance

A second consecutive year of strong absolute and relative performance allowed Royce Premier Fund to extend its relative advantages over its small-cap benchmark, the Russell 2000 Index, for the one-, three-, 10-, 15-, 20-, 25-year, and since inception (12/31/91) periods ended December 31, 2017. The Fund gained 23.8% in 2017, comfortably ahead of the Russell 2000, which was up 14.6% for the same period.

Breadth was solid in cyclical sectors, with Industrials, Information Technology, and Materials all doing well on an absolute basis.However, these sectors still trailed Health Care, the strongest performer in the small-cap index thanks to resurgent biotechnology companies.

What Worked… and What Didn't

Eight of the Fund’s nine equity sectors were positive contributors in 2017. Driven by the global technology buildout that benefited several portfolio holdings, Information Technology made by far the largest contribution, followed by Industrials. (These were also the portfolio’s two largest sector weightings at year-end). Energy detracted, but its negative impact was minor, thanks to some effective stock picking in a slumping area of the market.

The Fund’s relative advantage over the Russell 2000 came overwhelmingly from strong stock selection, most notably in Information Technology. Stock picking also provided a significant relative edge in Financials, in large part due to strong results for Ashmore Group, a U.K.-based asset manager specializing in emerging market fixed income.

Our underweight in banks also boosted relative results in the sector. Hurting relative results were our low weighting in Health Care, which included no exposure to biotechnology, and the portfolio’s cash position.

At the industry level, the electronic equipment, instruments & components group in Information Technology dominated, with two of the portfolio’s top-five contributors coming from this industry. Cognex Corporation is the market leader in machine vision technology, which captures and analyzes visual information to automate tasks that previously relied on human eyesight and is thus a major driver of industrial and process automation.

The firm has just begun to move into key end markets, such as consumer electronics, while adoption is expanding to other industries, including a fast-growing logistics segment. With ever-evolving proprietary technology and an unmatched global corps of engineers serving customers, we believe the firm looks poised to sustain its well-above-average returns on invested capital (ROIC) and compound its business value into the future.

IPG Photonics is the dominant provider of fiber lasers, which continue to take share from traditional industrial lasers in cutting, marking, and welding. Renewed demand in China fueled further growth in 2017 while Europe’s expanding economy bodes well for 2018. IPG also continually drove down costs while increasing the power of its core fiber lasers.

Moreover, three smaller technology acquisitions in 2017 expanded its addressable markets. From the semiconductors & semiconductor equipment group, MKS Instruments is the leading provider of critical components used in semiconductor manufacture. The firm continues to benefit from the transition to new chip architectures that require additional new equipment.

As for positions that detracted, CIRCOR International makes an array of valves and provides 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. We think it can eventually benefit from a recovery in energy prices and the further integration of a recent acquisition, which diversifies its end markets and brings higher margins, differentiated products, and aftermarket service revenue streams, factors that led us to add shares in the second half.

We chose to sell our position in MSC Industrial Direct, which supplies metalworking and maintenance and repair parts. Multiples were compressed as gross margins began to reflect pressure from Amazon’s revamped efforts to expand its own industrial distribution business. While its service-intensive metalworking business looked better insulated from the encroaching competition, we had doubts about the sustainability of its previous levels of ROIC for its more standard maintenance and repair operations, which account for about 50% of its business.

Top Contributors to Performance 20171 (%)

Cognex Corporation3.03
MKS Instruments2.08
IPG Photonics1.70
Westlake Chemical1.46

1 Includes dividends

Top Detractors from Performance 20172 (%)

CIRCOR International-0.51
MSC Industrial Direct Cl. A-0.32
Dorman Products-0.32
SEACOR Marine Holdings-0.27
Minerals Technologies-0.22

2 Net of dividends

Current Positioning and Outlook

We believe that high-ROIC small-cap companies can continue to outperform, which should benefit our strategy. Many of these companies are in cyclical areas, including Industrials and Information Technology, that we think have relatively more attractive valuations even after the strong run of the last two years. So while we are cautious about the prospects for small-cap returns as whole, we are also optimistic about our portfolio’s return potential as it leans towards three factors we believe will be well-rewarded going forward—high profitability, cyclicality, and global exposure.

We trimmed some holdings that appeared extended in 2017, particularly in the technology area, and invested more in high-quality cyclical companies in the paper and chemical industries, which looked well positioned to benefit from accelerating global growth.

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

Premier 6.2423.7723.7711.1111.688.7812.2710.9611.94 12/31/91

Annual Operating Expenses: 1.16

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 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, 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: Copart was 3.1%, Ashmore Group was 2.5%, MKS Instruments was 2.4%, Westlake Chemical was 2.2%, Cognex Corporation was 2.0%, Minerals Technologies was 2.0%, CIRCOR International was 1.8%, IPG Photonics was 1.7%, Dorman Products was 1.3%, MSC Industrial Direct Cl. A was 0.0%, SEACOR Marine Holdings 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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