Royce Special Equity Multi-Cap Fund Manager Commentary
article 02-12-2018

Royce Special Equity Multi-Cap Fund Manager Commentary

In a market led by growth stocks in 2017, the Fund performed largely in line with our expectations. 

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Fund Performance

Royce Special Equity Multi-Cap Fund uses the same classic value strategy that we have been using in its small-cap sibling for almost 20 years. Being designed and constructed more for potential downside protection, as well as potential capital preservation in highly volatile markets, the Fund performed largely in line with our expectations in 2017, and we were pleased with the Fund’s absolute results in a market that favored growth stocks in the calendar year. The Fund advanced 15.4% in 2017 versus a gain of 21.7% for its large-cap benchmark, the Russell 1000 Index, for the same period.

What Worked… and What Didn’t

Along with the market’s preference for high growth, there was a corresponding relative lack of attention paid to companies with steady earnings and pristine financials. These preferences shifted somewhat in the fourth quarter, allowing the Fund to outpace its benchmark (and pick up half of its calendar-year performance) with a 7.8% advance versus 6.6% for the Russell 1000.

The portfolio benefited most in the quarter from five holdings in three different sectors: industrial products and equipment maker Illinois Tool Works, motion control products maker Parker Hannifin (both from Industrials), home improvement business Lowe’s Companies, branded lifestyle apparel and footwear company VF Corporation (each from Consumer Discretionary), and technology behemoth Apple. Each was also among the top contributors to calendar-year performance.

The full year also saw five of the Fund’s six equity sectors make positive contributions to performance. Industrials—our largest sector and most significant overweight at year-end—led by a wide margin, followed by notable net gains for Information Technology. The only sector to detract from calendar-year performance was Materials, though its negative impact was quite modest, coming from underwhelming results for petroleum additive specialist NewMarket Corporation, our sole holding in the sector.

Within the Russell 1000, the strongest sector by far was Information Technology, which is more weighted toward growth companies. Health Care, which is even more tilted toward growth, was also a source of strength in the large-cap index, as was the economically sensitive cyclical area of Consumer Discretionary. The majority of the Fund’s 2017 underperformance came from ineffective stock selection in this last sector, where advances for VF Corporation, Lowe’s Companies, and McDonald’s could not overcome the relative negative effect of losses for retailer Dicks Sporting Goods, a position we finished selling in September.

As an example of the extremes to which many retail companies have gone over the last couple of years, Dicks was the portfolio’s top contributor in 2016. The secular and seismic shifts that Amazon has brought to so many retailers continue to register in highly impactful fashion.

We also parted ways with industrial supplies distributor W.W. Grainger and tool manufacturer Snap-on in 2017. The portfolio’s lower exposure to Information Technology also hampered relative performance, as did our cash position. Conversely, stock selection was a significant strength versus the Russell 1000 in Industrials, where a number of holdings did well, including the aforementioned Illinois Tool Works and Parker Hannifin, as well as multiline industrial conglomerate 3M and staffing services business ManpowerGroup.


Top Contributors to Performance 20171 (%)

Apple4.24
Illinois Tool Works2.84
Parker Hannifin2.45
VF Corporation1.67
Cisco Systems1.32

1 Includes dividends

Top Detractors from Performance 20172 (%)

Dicks Sporting Goods-3.57
Grainger (W.W.)-1.00
Snap-on-0.51
Avnet-0.45
NewMarket Corporation-0.14

2 Net of dividends

Current Positioning and Outlook

It remains an open question if the Fund’s strength in 2017’s final quarter marked a more lasting change. While perhaps too early to say for sure, it is clearly possible that a more discerning environment with an emphasis on quality may be upon us. It does not look likely to come without disruption, however. In what looks like a sign of a market increasingly vulnerable to a decline, the yield on the 2-year Treasury was higher than the dividend yield on the S&P 500 at the end of 2017 for the first time in nearly a decade.

With rates rising, along with prospective central bank balance sheet run-offs or reduced purchasing, the question is how long the bubble will remain inflated. We believe it will deflate. The only question is whether it will be gradual or sudden.

Over the past eight-and-a-half years, the S&P 500 has risen at a 17% average annualized rate off the March 2009 low that followed the Financial Crisis. That return is more than 10% higher on an average annualized basis than the long-term gain for the index.

Is this sustainable? Are not lower, even negative, returns soon likely? As Goldman Sachs recently wrote, “Elevated valuations increase the risk of draw-downs for the simple reason that there is less buffer to absorb shocks.”

We believe that our highly concentrated portfolio appears well-positioned to benefit from a more volatile and corrective phase as it holds profitable companies that also have little debt. We have carefully sifted through the deck and like what we own as we embark on 2018.

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

QTR1 YTD1 1YR 3YR 5YR SINCE INCEPT. DATE
Special Equity Multi-Cap 7.8415.4215.424.2611.0310.56 12/31/10
Russell 1000 6.5921.6921.6911.2315.7113.66 N/A

Annual Operating Expenses: Gross 1.34 Net 1.24

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.

All performance and risk information presented in this material prior to the commencement date of Investment Class shares on 3/1/12 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: Apple was 8.9%, Illinois Tool Works was 8.3%, Parker Hannifin was 5.8%, Lowe's Companies was 5.5%, Cisco Systems was 5.2%, McDonald's Corporation was 3.5%, ManpowerGroup was 2.6%, NewMarket Corporation was 2.6%, 3M was 1.5%, Avnet was 0.0%, Dicks Sporting Goods was 0.0%, Grainger (W.W.) was 0.0%, Snap-on was 0.0%, VF Corporation 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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