Royce Opportunity Fund Manager Commentary
article 06-30-2017

Royce Opportunity Fund Manager Commentary

Driven by the success of tech holdings, the Fund handily outperformed its small-cap benchmark, the Russell 2000, in the first half.


Fund Performance

Royce Opportunity Fund advanced 8.2% for the year-to-date period ended June 30, 2017, outperforming its small-cap benchmark, the Russell 2000 Index, which was up 5.0% for the same period. We were especially pleased with the success of our deep value approach because it came in a period that was otherwise highly challenging for value stocks. The Russell 2000 Value Index was up 0.5% in 2017’s first half versus 10.0% for the Russell 2000 Growth.

Opportunity outpaced the Russell 2000 in the first quarter, up 5.2% versus a 2.5% gain, while in the second quarter, the Fund increased 2.8% compared to 2.5% for the benchmark. We were also happy with longer-term results on both an absolute and relative basis. The Fund outperformed the Russell 2000 for the one-, five, 15-, 20-year, and since inception (11/19/96) periods ended June 30, 2017. Opportunity’s average annual total return since inception was 12.4%.

What Worked… And What Didn’t

Seven of the Fund’s 11 equity sectors made contributions to first-half results, with the most impressive result coming from Information Technology. We did much of the seed work in tech stocks 18-24 months ago, when a slow business cycle lowered share prices in many industries in which we have a perennial interest, such as semiconductors and electronic components. In fact, much of the appeal of technology stocks is that the business cycle tends to go to extremes on both the up and the down side, which often creates attractive opportunities as long as one has the patience to wait and the discipline to endure falling prices. In addition, other value investors tend to avoid or underinvest in these companies, which in our view often enhances the attractiveness of the valuations.

The recovery we’ve seen in many technology companies over the last several months has been keyed by one of the largest buildouts since the early days of the Internet. The expansion encompasses multiple developments and innovations, including the move from 4G to 5G, artificial intelligence, autonomous driving, public and private cloud storage, and the expansion of the semiconductor industry in China. Prices in many cases began to exceed our sell targets in the spring, leading us to trim our overall exposure to the sector. However, we are confident that the buildout is in its early stages, so we will be watching carefully (as we always do) for opportunities to materialize.

Three industry groups from the sector drove first-half results for the Fund as a whole—semiconductors & semiconductor equipment, electronic equipment, instruments & components, and communications equipment. KEMET Corporation, a solid tantalum and multilayer ceramic capacitor manufacturer that was also one of the top contributors in 2016’s fourth quarter was the Fund’s top performer at the position level. Strong sales and earnings combined with margin expansion to fuel the rise of its shares. Both Brooks Automation, which offers automation-oriented software and hardware for semiconductors, and capital equipment subsystem provider Ultra Clean Holdings benefited from high demand for semiconductor equipment while environmental, engineering, and construction business TRC Companies (from the Industrials sector) proved a profitable acquisition target.

Of the four sectors that detracted from first-half results, only Energy had a significant negative impact—net losses for Telecommunication Services, Consumer Staples, and Real Estate were comparatively minor. This carried over to the industry level, where declining oil prices led to disappointing results for energy equipment & services and oil, gas & consumable fuels. The former industry is home to Matrix Service, a contractor to the energy, power, and industrial markets. Ongoing delays in new project awards and starts, depressed maintenance spending, and increased cost estimates on an electrical infrastructure project all discouraged investors. We chose to build our position based on a cautiously optimistic longer-term outlook.

We received shares of Windstream Holdings after it bought a former portfolio holding and combined the two companies’ businesses. Fiscal first-quarter losses discouraged investors, notwithstanding management’s more optimistic full-year guidance for service revenue, free cash flow, and adjusted income. Our view was that its participation in growing markets and attractive assets made it worth holding.

The Fund’s biggest relative advantage in the first half came from stock selection in Information Technology, where our larger weighting also helped. Stock selection in Industrials and a lower exposure to Financials also provided a relative edge. Conversely, our lack of exposure to biotechnology (Health Care) hurt relative performance as did our cash position and stock selection in Telecommunication Services.

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

KEMET Corporation0.83
TRC Companies0.59
Brooks Automation0.51
Ultra Clean Holdings0.50
Kratos Defense & Security Solutions0.49

1 Includes dividends

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

Matrix Service-0.34
Windstream Holdings-0.27
Tower International-0.24
Wesco Aircraft Holdings-0.24
Unisys Corporation-0.24

2 Net of dividends

Current Positioning and Outlook

We remain encouraged by the pace of global economic growth, which should have a positive impact on the capital goods sector. We began to reduce some positions in Information Technology prior to June’s sell-off based on their lofty valuations, while we maintained most of our holdings in Industrials. We have also been looking to take advantage of improved consumer income by adding select names in Consumer Discretionary. In addition, we reduced the portfolio’s exposure to Financials as valuations for many holdings appeared full relative to where we began to buy three to five years ago. Finally, we benefited from a number of takeovers.

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

Opportunity 2.818.1736.105.4613.836.5910.2511.9512.39 11/19/96

Annual Operating Expenses: 1.18

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 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, 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: KEMET Corporation was 0.8%, TRC Companies was 0.0%, Brooks Automation was 0.5%, Ultra Clean Holdings was 0.4%, Kratos Defense & Security Solutions was 1.2%, Matrix Service was 0.4%, Windstream Holdings was 0.3%, Tower International was 1.0%, Wesco Aircraft Holdings was 0.7%, Unisys Corporation was 0.6%.

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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