Royce Total Return Fund Manager Commentary
article 02-12-2018

Royce Total Return Fund Manager Commentary

Favorable tailwinds helped the Fund overcome challenges in the first half of 2017 to outperform the Russell 2000 Index in the second half.


Fund Performance

During a year in which growth stocks led and small-caps that pay no dividends outpaced those that do, we were pleased with the calendar-year results for Royce Total Return Fund. The Fund was up 13.7% in 2017 versus 14.6% for its small-cap benchmark, the Russell 2000 Index, for the same period. Our dividend value approach proved most effective in the second half of the year, when the Fund gained 10.6% versus 9.2% for the small-cap index.

What was most notable about the Fund’s advantage over this six-month period was that both small-cap dividend payers and value stocks underperformed in the Russell 2000. Fortunately, the portfolio also experienced some favorable tailwinds in the second half in the form of renewed strength for cyclical stocks—particularly those with global exposure.

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

What Worked… and What Didn't

Seven of the Fund’s 11 equity sectors made positive contributions to 2017 performance. Industrials, Financials, and Materials led, the first two by a comfortable margin. The impact of detractors at the sector level was comparably quite modest, with Consumer Staples, Telecommunication Services, and Energy all posting relatively minor net losses.

Within the Russell 2000, Health Care was 2017’s top performer, led by biotechnology stocks. Our exposure to the sector was both low and highly selective (as it has been historically) because few healthcare companies pay dividends. Our significant underweight was therefore the largest source of underperformance in 2017. Ineffective stock selection in Consumer Discretionary also detracted, most notably in household durables.

Conversely, relative results were helped by our positions in Financials, where sector outperformance was driven primarily by superior stock selection, notably in banks and capital markets. Our underweight in banks, which lagged in 2017, also helped, as did an overweight and savvy stock selection in Materials, where chemical companies were the standouts.

Three groups dominated absolute results at the industry level—the aforementioned capital markets and chemicals groups as well as machinery (Industrials). As was the case with sectors, the impact of detractors was lighter, led by specialty retail (Consumer Discretionary), technology hardware, storage & peripherals (Information Technology), and food products (Consumer Staples).

Four of the Fund’s top-five contributors were also top-10 positions at year-end. Staffing services business ManpowerGroup benefited from improved employment trends in the U.S. and Europe as well as its optimistic expectations for broad-based global improvement in both hiring trends and economic growth.

Albemarle Corporation is a specialty chemicals company that specializes in lithium, which is used to make ion batteries. Their attractive combination of high energy density and relatively low maintenance makes these batteries a popular choice for electric vehicles and local energy storage applications—each a burgeoning technology niche. Growing demand helped to energize Albemarle’s stock price.

Recreational vehicle maker Thor Industries gave investors a smooth ride as sales to a widening demographic, which includes Baby Boomers, Gen X-ers, and millennials, paved the way to better-than-expected earnings.

As for holdings that detracted from 2017 results, HNI Corporation makes office furniture and hearth products. Its shares fell when the firm announced strong fiscal third-quarter earnings while at the same time reducing its fourth-quarter guidance based on expectations of lower volumes, increased costs, and an unfavorable business and product mix. Although we reduced our position in the second half, we were hopeful at year-end that these were temporary problems.

The Cato Corporation is a fashion retailer that struggled with declining same-store sales and the related challenges of competing in an industry increasingly dominated by Amazon’s margin-contracting omnipresence, factors that led us to significantly reduce our stake in 2017.

We acted similarly with our position in ATM provider Diebold Nixdorf, which is still transitioning to a service-based, software-centric business. While recent results showed improvement on a quarter-over-quarter basis, investors were disappointed, and its near-term prospects looked uncertain to us at year-end.

Top Contributors to Performance 20171 (%)

Albemarle Corporation0.58
Thor Industries0.58
MKS Instruments0.53

1 Includes dividends

Top Detractors from Performance 20172 (%)

HNI Corporation-0.27
Cato Corporation (The) Cl. A-0.27
Diebold Nixdorf-0.26
Ethan Allen Interiors-0.21

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 extend its second-half outperformance into the years ahead. If small-caps experience a correction, then we are hopeful that the Fund’s historical lower volatility profile will help mitigate the effects of a decline.

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

Total Return 4.4113.6513.659.9012.307.9810.009.3711.04 12/15/93

Annual Operating Expenses: 1.21

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, 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 its investments 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: ManpowerGroup was 1.6%, Albemarle Corporation was 1.2%, Thor Industries was 1.5%, Teleflex was 1.2%, MKS Instruments was 1.4%, HNI Corporation was 0.5%, Cato Corporation (The) Cl. A was 0.1%, Diebold Nixdorf was 0.4%, Ethan Allen Interiors was 0.7%, Genesco 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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