Royce International Discovery Fund Manager Commentary
article 06-30-2018

Royce International Discovery Fund Manager Commentary

Although the Fund trailed its benchmarks, we continue to find attractive investment opportunities in both developed and emerging markets.

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Fund Performance

Tariff and trade war talk, a strengthening dollar, and market and economic softness in China and Europe all had a dampening effect on non-U.S. stocks of all sizes in the first half of 2018. Royce International Discovery Fund was down 6.2% for the year-to-date period ended June 30, 2018, underperforming its benchmark, the Russell Global ex-U.S. Small Cap Index, which declined 3.8% for the same period.

What Worked… And What Didn’t

Of the Fund’s 10 equity sectors, six detracted from first-half results, with the largest negative impacts coming overwhelmingly from Industrials and Consumer Discretionary, its two largest sectors at the end of June. Industrials was also a substantial overweight relative to the benchmark. At the position level, three of the portfolio’s five biggest detractors came from this same sector. Atento is Latin America’s largest provider of customer relationship management and business process outsourcing (“CRM BPO”) services. Its stock price suffered in late 2017 after a secondary offering of shares was poorly received. In March of 2018, its shares again slipped when it reported a quarterly loss. While its Latin American end markets remain volatile, Atento is the dominant player in these markets and was also trading at a hefty discount to its global peers. This led us to add shares in the first half. Asian Granito India is one of India’s top tile manufacturers. Profit and revenue growth were not enough to offset a falling rupee, rising oil prices, and the slowing pace of global growth—all of which turned market sentiment negative, with Indian small-caps hit especially hard. Uncertain about its prospects in this climate, we sold our shares in June. We also exited our position in Magellan Aerospace, a Canadian company that manufactures engine and other components for customers in Canada, the U.S., and Europe. In early May, the company reported weaker-than-expected results rooted mostly in the expense of building a new manufacturing facility and a volatile British pound. Outside of Industrials, we built our position in Eugene Technology when uneven quarterly revenue growth and concerns that the semiconductor cycle had peaked combined to bring down its share price. Based in South Korea, Eugene is a semiconductor equipment maker that specializes in single-wafer type thermal insulation equipment. We like its niche and expect a revival in demand for its products.

The Fund’s top contributor at the position level in 2017, Conviviality fell to being by far its most significant detractor in the first half of 2018. The firm is a liquor distributor in the U.K. that also operates franchised off-license and convenience chain stores. Conviviality unraveled in short order in 2018, after it issued a pair of profit warnings, admitted to having a large, previously undiscovered tax bill, and unsuccessfully attempted to raise capital from investors to stave off liquidation. Needless to say, its management proved to be far less capable than investors had thought during its period of early success. 


The top contributor at the position level was Hua Hong Semiconductor, a manufacturer of 200 millimeter wafers for specialized applications. Its shares benefited from impressive sales and earnings growth as well as the Chinese government’s push to source native semiconductor production. We reduced our position as its stock rose. TCI is a Taiwanese contract manufacturer of dietary supplements, health drinks, and skin care. Its shares were nourished by strong sales and earnings growth driven mostly by Chinese consumer demand and the company’s near-term positive outlook. Norway’s Leroy Seafood Group produces and distributes seafood around the globe, with a core business producing salmon, trout, and whitefish. Concerns that salmon prices were peaking allowed us to purchase shares at historically low multiples early in 2018. When subsequent earnings were better than expected accompanied by a more positive outlook on salmon prices, its shares jumped more than 60% from previous lows, which prompted us to sell our shares.


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Relative to the benchmark year-to-date, the portfolio’s largest disadvantage came from ineffective stock selection in the Consumer Staples and Consumer Discretionary sectors, while it benefited from better stock picking in Financials, Telecommunication Services, 
and Materials.


Top Contributors to Performance Year-to-Date Through 6/30/181 (%)

Hua Hong Semiconductor0.77
TCI0.45
Leroy Seafood Group0.41
China Resources Cement Holdings0.36
HT&E0.35

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/182 (%)

Conviviality-1.24
Atento-0.58
Asian Granito India-0.45
Eugene Technology-0.36
Magellan Aerospace-0.35

2 Net of dividends

Current Positioning and Outlook

The combination of a modest slowdown in international growth, rising emerging market instability, a stronger dollar, and heightened trade war concerns led investors to prefer a more limited menu of domestic offerings in the first half. In fact, 35 of the 45 non-U.S. small-cap markets that we follow had declines in the first half of 2018 (though only 26 were negative when measured in local currencies). Non-U.S. companies therefore faced major challenges, particularly in emerging market economies where fears of potential currency declines drove many investors to pull money out of these geographies. From a valuation standpoint, the U.S. market remained one of the most expensive in the world at the end of June, a distinction it has held for the better part of the past 10 years. In this environment, we continue to find attractive investment opportunities in both developed as well as emerging markets, where companies in India, Brazil, and Indonesia looked particularly interesting to us at June 30.

Average Annual Total Returns Through 06/30/18 (%)

QTR1 YTD1 1YR 3YR 5YR SINCE INCEPT. DATE
International Discovery -4.15-6.213.965.488.033.62 12/31/10
Russell Glo x US SC -3.45-3.789.177.158.035.05 N/A

Annual Operating Expenses: Gross 2.79 Net 1.44

1 Not annualized.

Important Performance, Expense 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 2% 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. Gross operating expenses reflect the Fund's total gross annual operating expenses and include management fees, 12b-1 distribution and service fees, and other expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund’s most current prospectus. Royce & Associates has contractually agreed to waive fees and/or reimburse operating expenses to the extent necessary to maintain the Fund's net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below 1.44% through April 30, 2019 and at or below 1.99% through April 30, 2028.

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 June 30, 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 June 30, 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 6/30/18, the percentage of Fund assets was as follows: Hua Hong Semiconductor was 1.0%, TCI was 0.6%, Leroy Seafood Group was 0.0%, China Resources Cement Holdings was 0.5%, HT&E was 1.1%, Conviviality was 0.0%, Atento was 1.9%, Asian Granito India was 0.0%, Eugene Technology was 1.0%, Magellan Aerospace 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 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 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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