Royce Opportunity Fund Manager Commentary
article 06-30-2018

Royce Opportunity Fund Manager Commentary

After two stellar years of absolute and relative performance, our small-cap deep value approach was affected by tariffs and trade disruption on industrial holdings.


Fund Performance

After two consecutive years of strong absolute and relative performance, we were not terribly surprised to see the pace of returns moderate for our small-cap deep value approach in the first half of 2018. Royce Opportunity Fund increased 4.1% for the year-to-date period ended June 30, 2018, trailing both of its small-cap benchmarks, the Russell 2000 Index, which rose 7.7%, and the Russell 2000 Value Index, which was up 5.4%, for the same period. However, the Fund outperformed both indexes for the three-, 10-, 15-, 20-year, and since inception (11/19/96) periods ended June 30, 2018 and was also ahead of the small-cap value index for the one- and five-year periods ended June 30, 2018.

What Worked… And What Didn’t

Information Technology led a group of eight (out of 11) equity sectors with positive contributions in the first half, followed by Financials. Net losses from Consumer Discretionary, Health Care, and Industrials made just a minor collective impact. The top industry by a considerable margin was the electronic equipment, instruments & components group, which has been a consistent performance driver over the last two years. KEMET Corporation, a solid tantalum and multilayer ceramic capacitor manufacturer, has been a large part of its success. We have acted opportunistically with its shares, buying late in 2017 when its price fell on what looked to us like a minor earnings disappointment and trimming in 2018 when its stock recovered. Elsewhere in the tech sector, Comtech Telecommunications saw improved demand for its advanced communications applications in its commercial and, to an even greater extent, military end markets. KEMET and Comtech were also the portfolio’s two largest holdings at the end of June. From the Consumer Discretionary sector, Enova International is a payday lender that expanded its roster of offerings to include installment loans and lines of credit that are not subject to banking regulations. High demand for these services helped to drive its shares higher, which led us to reduce our position.

In the case of Basic Energy Services, a tumbling stock price presented opportunities to build our position in the expectation of an eventual turnaround. Basic Energy provides oil and gas companies with well site services, such as well maintenance, pumping, and contract drilling. It emerged from bankruptcy before we bought shares. During the first half of 2018, earnings were hurt by more weakness than was expected outside its core markets. We, on the other hand, think its key end markets are still attractive. We held our shares of automotive products and services company Dana in the belief that it could continue to execute successfully. We chose to do the same with Westport Fuel Systems, which offers alternative fuel systems and components for the transportation and industrial markets worldwide. Delays in the expected uptick in revenues from newer business in European markets led to an aggressive sell off that we anticipate will reverse.

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Relative to the benchmark, the Fund’s biggest trouble spots were poor stock selection and much lower exposure to Health Care and ineffective stock picks in Consumer Discretionary. Our large overweight in Industrials, along with some stock selection difficulties, also hurt relative results in the first half of 2018. Conversely, stock selection was a major advantage versus the Russell 2000 in Financials, where our underweight also contributed and where the consumer finance industry provided a source of relative outperformance. Slighter relative advantages came from a stock selection edge in Materials and the portfolio’s much lower weightings in Real Estate and Utilities.


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

Enova International0.56
Comtech Telecommunications0.46
KEMET Corporation0.44
DMC Global0.38
Whiting Petroleum0.34

1 Includes dividends

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

Basic Energy Services-0.41
Westport Fuel Systems-0.27
Aceto Corporation-0.24

2 Net of dividends

Current Positioning and Outlook

The U.S. economy continues to strengthen, which we see as a positive for many holdings, in particular those in Information Technology and Industrials. We saw the negative effect of tariffs and trade disruption on many industrial holdings that had performed well previously before giving back some of their gains in the first half, creating a curious situation in which the stocks showed weakness even as the companies reported strong results. We think the ultimate resolution of these issues should provide recovery in this sector. We like industrial businesses with exposure to aerospace & defense, energy, and infrastructure. In technology, automation, cloud storage, and other innovations are moving forward with the consequence that companies must adopt newer technologies out of necessity, which should create ongoing, though cyclical—and at times volatile—demand for companies involved in semiconductor and capital equipment manufacturing, as well as other related industries. These positions, along with still recovering holdings in Consumer Discretionary and Energy, make us pleased with how the portfolio is positioned as we anticipate ongoing economic growth.

On October 1, 2018, Boniface A. ‘Buzz’ Zaino will step down as the Lead Portfolio Manager of the Fund, which he has managed since joining Royce in April 1998. Bill Hench, who has worked with Buzz since 2002 and has long been designated as Buzz’s successor, will become the Fund’s sole portfolio manager effective on that same date. Bill has managed the Fund with Buzz since 2013 after serving as assistant portfolio manager from 2004-2013. Buzz will stay on at Royce as a Senior Adviser to the portfolio team.

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

Opportunity 6.724.0517.2312.2411.4011.1511.4811.9312.61 11/19/96

Annual Operating Expenses: 1.20

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 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 and other expenses.

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: Enova International was 0.2%, Comtech Telecommunications was 1.0%, KEMET Corporation was 1.1%, DMC Global was 0.4%, Whiting Petroleum was 0.6%, Basic Energy Services was 0.4%, Dana was 0.7%, Westport Fuel Systems was 0.6%, MaxLinear was 0.4%, Aceto 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 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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