Royce Total Return Fund Manager Commentary
article 02-14-2019

Royce Total Return Fund Manager Commentary

Despite a mostly inhospitable market environment over the last three years for our cautious, dividend-centric approach, the Fund beat its benchmark for the three-year period ended 12/31/18.

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Fund Performance

Royce Total Return Fund was down 12.5% in 2018, lagging the Russell 2000 Index, its small-cap benchmark, which fell 11.0% for the same period. While disappointed by our underperformance, we were nonetheless pleased that the Fund was able to narrow the performance gap during the stormy fourth quarter, when its historical resilience in downturns was once again in evidence as it lost 15.3% compared to a 20.2% decline for the Russell 2000. This marked the index’s tenth negative quarter over the last decade—and the Fund outperformed in eight of them, consistent with what its lower volatility dividend value strategy seeks to deliver. Despite a mostly inhospitable market environment over the last three years for our cautious, dividend-centric approach, the Fund beat its benchmark for the three-year period ended December 31, 2018.

What Worked… And What Didn’t

The portfolio saw declines in nine of the 11 equity sectors where it had investments in 2018, and its two largest, Financials and Industrials, were also its biggest detractors by a wide margin. Materials and Information Technology followed. Positive contributions at the sector level were small, with Health Care and Consumer Staples the only areas to finish 2018 in the black.

Banks and capital markets, two groups in Financials, detracted most at the industry level. Bank stocks in general slumped on fears of a flattening yield curve, slower-than-expected loan growth, and fears that a recession would mean increased loan losses. Two of our holdings—BOK Financial and Canadian Western Bank, also felt the negative effects of oil price declines owing to their locations in energy-focused regions. We remain constructive on our holdings as a group, however, based on the belief that the long-term direction of interest rates is upward, with a steepening yield curve. The banks we hold are also mainly smaller community-centered businesses where we saw attributes that go beyond the overall improved conditions for the industry that should help them recover. They have some combination of a strong deposit franchise, impressive loan growth, and/or a strong geographic advantage. The Fund’s holdings in capital markets are a mix of alternative and traditional asset management businesses, most of which suffered the steep declines that down markets often wreak on these businesses.


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The Fund’s biggest detractor at the position level was ManpowerGroup, an Industrials holding that provides workforce solutions and services to a global market. Its 2018 revenues slid, as the economic environment, particularly in its European business, proved more challenging than the company had been anticipating. We held shares based on the ongoing strength of its North American and Asian business and its record of successful execution. The long-term prospects for recreational vehicle manufacturer Thor Industries inspired a similar level of confidence in spite of a 65% decline for its stock in 2018. Sales began to decline in the fall, forcing Thor to scale back production as independent RV dealers had overstocked their inventories earlier in the year. However, inventories were normalizing at the end of December, and Thor has also improved its production process in order to meet variable levels of demand.

Positive contributions at both the industry and position levels were very modest. Aerospace & defense (Industrials) was boosted by strength for HEICO Corporation, which supplies electronics and other parts to aerospace companies. Its defensible moat in a highly specialized niche and conservatively capitalized balance sheet attracted our attention while other investors seemed drawn to its steady earnings growth in 2018. A Consumer Staples holding, Lancaster Colony makes specialty food products for the retail and foodservice channels. Its shares were nourished in the second half of 2018 by strong sales growth and margin expansion in its fiscal first quarter.

The Fund’s 2018 underperformance resulted from sector allocation—stock selection was additive for the year. Information Technology was by far the biggest source of underperformance due both to our underweight and ineffective stock selection. Consumer Discretionary holdings also detracted from relative results. Conversely, Energy contributed most to relative results as the Fund’s holdings in the energy equipment & services industry did significantly better than those in the index. Consumer Staples stocks were another a source of outperformance, with food & staples retailing contributing most, led by Village Super Markets.


Top Contributors to Performance 20181 (%)

HEICO Corporation0.25
Lancaster Colony0.22
American Railcar Industries0.20
Shoe Carnival0.20
Quaker Chemical0.19

1 Includes dividends

Top Detractors from Performance 20182 (%)

ManpowerGroup-0.72
Thor Industries-0.60
Methode Electronics-0.46
Clarkson-0.40
Hubbell Cl. B-0.31

2 Net of dividends

Current Positioning and Outlook

While we acknowledge the many potential sources of risk on the horizon—economic, geopolitical, and financial—we also think that these concerns have already been largely reflected, perhaps even excessively so, in current valuations. In relatively short order, we transitioned from a period this summer when small-cap’s extended valuations seemed out of sync given the index’s high levels of debt and low profitability, to one at the end of the year where valuations seemed more pessimistic than we think is warranted—at least in select instances. As a result, we reduced the Fund’s cash holdings to a minimal amount by year-end. Historically, down years for small-caps have often been followed by strong ones. We believe that the portfolio’s cyclical tilt will be rewarded as recessionary concerns dissipate during the year.

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

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Total Return -15.34-12.46-12.467.783.3210.617.148.399.99 12/15/93
Russell 2000 -20.20-11.01-11.017.364.4111.977.507.408.42 N/A

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 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 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, 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: HEICO Corporation was 1.0%, Lancaster Colony was 1.1%, American Railcar Industries was 0.0%, Shoe Carnival was 0.2%, Quaker Chemical was 1.9%, ManpowerGroup was 1.1%, Thor Industries was 0.5%, Methode Electronics was 0.9%, Clarkson was 0.8%, Hubbell Cl. B was 1.0%, BOK Financial was 1.3%, Canadian Western Bank was 0.6%, Village Super Markets was 1.1%


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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