Royce Low-Priced Stock Fund Manager Commentary
article 06-30-2017

Royce Low-Priced Stock Fund Manager Commentary

The Fund was challenged by leadership shifts in the first half that favored growth stocks, healthcare, and non-U.S. equities.


Fund Performance

Royce Low-Priced Stock Fund was up 1.0% for the year-to-date period ended June 30, 2017, trailing its small-cap benchmark, the Russell 2000 Index, which gained 5.0% for the same period. The leadership shifts that characterized the first quarter of 2017 remained in place for most of the second quarter as well, as growth stocks, large-caps, healthcare, and non-U.S. equities all stayed in the lead after lagging in 2016.

The Fund was flat in the first quarter, returning 0.0% while the Russell 2000 was up 2.5%. There was some improvement on an absolute basis in the second quarter, with the Fund advancing 1.0% versus a 2.5% gain for the small-cap benchmark. Low-Priced Stock outperformed the Russell 2000 for the 20-year and since inception (12/15/93) periods ended June 30, 2017. The Fund’s average annual total return since inception was 9.9%.

What Worked… And What Didn’t

Five of the portfolio’s 11 equity sectors made positive contributions to first-half performance. Information Technology led by a sizable margin, followed by notable net gains for Health Care and Industrials. Of the six sectors that detracted from results, only Consumer Discretionary and Energy made appreciable negative impacts. At the industry level, health care equipment & supplies (Health Care) made the biggest contribution, followed by two groups in Information Technology—semiconductors & semiconductor equipment and electronic equipment, instruments & components. Energy equipment & services (Energy), where tumbling oil prices impacted the shares of tech-based energy product maker Tesco Corporation, and chemicals (Materials) were among the industries that detracted most.

No industry group, however, had a bigger negative effect than specialty retail (Consumer Discretionary), which continues to struggle with shifts in consumer spending and shopping habits, along with the ensuing margin contraction, developments keyed to a large degree by the omnipresence of Amazon. Two holdings from this industry detracted most from the Fund’s first-half results at the position level. Value-priced department store operator Stein Mart suffered from ongoing sales pressure associated with the shift to online shopping. This formidable challenge was exacerbated by a series of internal merchandising miscues. Despite our concern about the long-term shift to online, we held a small position at the end of the first half based on our view that correcting the internal miscues should provide a better exit point. We chose to sell our position in Ascena Retail Group, which is a holding company for several national chains of women’s and girls’ clothing stores, including Ann Taylor, Lane Bryant, and Justice, in the face of declining sales.

The Fund’s top contributor at the position level was Canadian medical device maker Novadaq Technologies. The company provides a unique solution in the rapidly growing intraoperative fluorescent imaging market. The company’s products, which are used primarily to treat vascular and ophthalmic diseases and conditions, allow clinicians to make better informed decisions during surgery and have very good safety profiles. Reflecting the strength of its technology, Novadaq was the subject of a proposed acquisition by industry leader Stryker Corporation, prompting us to sell our position in June at an attractive premium. Top-20 holding Kratos Defense & Security Solutions is a defense contractor offering services in weapons systems lifecycle support, military weapon range, and security and surveillance systems. Increased revenue and earnings were driven by ongoing high demand for its satellite communications, cybersecurity, and technology and training divisions.

Relative to the Russell 2000, stock selection woes in Consumer Discretionary, mostly in specialty retail, hurt first-half results most. Our much lower weighting in Health Care—where biotechnology led the small-cap index—and stock picks in Materials also affected relative results, but made a comparatively smaller negative impact. Conversely, stock selection was a strength in Industrials and in the struggling Energy sector, while our lower weighting in banks—as well as stock picking in that industry and in capital markets—gave us a relative edge in Financials.

Top Contributors to Performance Year-to-Date Through 6/30/171 (%)

Novadaq Technologies0.43
Kratos Defense & Security Solutions0.37
Kirkland Lake Gold0.34
Zealand Pharma0.28

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/172 (%)

Stein Mart-0.48
Ascena Retail Group-0.45
Tesco Corporation-0.32
Inventure Foods-0.28

2 Net of dividends

Current Positioning and Outlook

We made no significant changes to the portfolio during the first half. At the end of June, we remained overweight in the Fund’s three largest sectors: Information Technology, Industrials, and Consumer Discretionary while also having more exposure to Energy. Consumer stocks across several industries provide some of the most intriguing valuations among low-priced stocks, although these must be balanced against the significant challenges retailers face as market share continues its inexorable march to online shopping and, at least for the foreseeable future, reduced margins.

We view both industrial and energy stocks as well positioned to benefit from a more relaxed U.S. regulatory environment and also continue to see a number of secular trends such as the Internet of Things and mobile computing that carry positive implications for small-cap technology companies with attractive niche businesses. Finally, while we remained substantially underweight in Health Care, we have been selectively adding to positions in later-stage, niche medical device companies that we believe have created defensible competitive positions.

Average Annual Total Returns Through 06/30/17 (%)

Low-Priced Stock 0.970.9720.17-2.373.882.096.218.949.91 12/15/93

Annual Operating Expenses: Gross 1.61 Net 1.58

1 Not annualized.

Important Performance, Expense, and Disclosure 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 Gross operating expenses reflect the Fund's total gross annual operating expenses and include management fees, other expenses, and acquired fund fees and 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, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Investment Class'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 1.24% through April 30, 2018. 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.

All performance and risk information presented in this material prior to the commencement date of Investment Class shares on 3/15/07 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 June 30, 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 June 30, 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 6/30/17, the percentage of Fund assets was as follows: Novadaq Technologies was 0.0%, Kratos Defense & Security Solutions was 0.8%, Novanta was 0.7%, Kirkland Lake Gold was 0.8%, Zealand Pharma was 1.1%, Stein Mart was 0.2%, Ascena Retail Group was 0.0%, Tesco Corporation was 0.5%, BioAmber was 0.3%, Inventure Foods was 0.4%.

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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