Royce Pennsylvania Mutual Fund Manager Commentary
article 06-30-2017

Royce Pennsylvania Mutual Fund Manager Commentary

The Fund managed well in a first half in a market that showed more favor to high growth and low quality than the kind of companies we seek with the Fund’s diversified, multi-theme core approach.

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Fund Performance

Royce Pennsylvania Mutual Fund advanced 4.8% for the year-to-date period ended June 30, 2017, slightly trailing its small-cap benchmark, the Russell 2000 Index, which rose 5.0% for the same period. After a terrific absolute and relative showing in 2016—our flagship Fund’s fourth-best return in the last 25 years—some pullback was not surprising, especially in a period that showed more favor to high growth and low quality than the kind of companies we seek using Penn’s diversified, multi-theme core approach.

In this more challenging environment, the Fund posted a modest first-quarter return (+1.5%) while lagging the benchmark (+2.5%). Several healthcare names from outside the resurgent biotechnology industry keyed Penn’s strong second-quarter results, up 3.2% versus 2.5% for the small-cap index. Looking at longer-term periods, we were pleased that Penn outpaced the Russell 2000 for the 15-, 20-, 25-, 30-, and 35-year periods ended June 30, 2017. The Fund’s average annual total return for the 40-year period ended June 30, 2017 was 13.1%, all under the management of Chuck Royce.

What Worked… And What Didn’t

Eight of the Fund’s 11 equity sectors finished the semiannual period in the black (a ninth, Telecommunication Services, was essentially flat). Consumer Discretionary and Energy detracted, the first hurt by secular shifts in consumer spending and behavior, the second by falling oil prices. The most notable positive impacts came from Information Technology, Industrials (the Fund’s two largest sectors), and Health Care. The last is an area in which we have been active in 2017, increasing the Fund’s exposure to 10.2% at the end of June from 6.8% at the end of 2016.

Consistent with our usual practice, we have mostly avoided the more speculative environs of the sector and instead have been concentrating on cash-flow generating companies with earnings in industries that have been historically less volatile than those in the bio-pharma complex. The result at the end of June was a comparatively larger weighting within the portfolio in equipment makers and suppliers, service providers, and life sciences tool manufacturers, many of which, including Merit Medical Systems, helped drive second-quarter results.

Electronic equipment, instruments & components made the largest contribution at the industry level during 2017’s first half, led by the Fund’s three best performing positions for the period. Laser diode and equipment maker Coherent took the top spot, as it did in 2016, galvanized by ongoing sales and earnings growth driven by vibrant demand for ramped up OLED (organic light-emitting diode) capacity.

IPG Photonics, which produces high-power fiber lasers and amplifiers, also saw earnings growth push its shares higher as the company continued to benefit from the accelerated pace with which its fiber lasers are replacing conventional lasers and non-laser technology on a global scale. Cognex Corporation is the market leader in machine vision technology, which captures and analyzes visual information to automate tasks that previously relied on human eyesight and is thus a major driver of industrial and process automation. The trend toward automation continues to improve order strength for its machine vision systems.

Only two industries made sizable negative impacts on first-half results—specialty retail and energy equipment & services. The Fund’s leading detractor overall, however, was Core-Mark Holding Company, which comes from the distributors industry within Consumer Discretionary. The company specializes in supply and distribution services to convenience stores in the U.S. and Canada. Although profitable, Core-Mark reported lower-than-expected fiscal first-quarter earnings in May, which helped to send its shares lower. We reduced our stake in the first half prior to the announcement. Matrix Service is a contractor to the energy, power, and industrial markets. Its close association with the reeling energy industry, ongoing delays in new project awards and starts, depressed maintenance spending, and increased cost estimates on an electrical infrastructure project all discouraged investors, including us. We sold the last of our shares in Penn’s portfolio in June.

Relative to the Russell 2000, poor stock selection in Consumer Discretionary—most impactfully in that sector’s specialty retail group—hurt most while our underweight in biotechnology also created a relative disadvantage. In contrast, Financials were strong relative contributors, aided by savvy stock selection and an underweight in banks, while effective stock picking in machinery stocks gave us an edge in Industrials.


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

Coherent0.55
IPG Photonics0.33
Cognex Corporation0.32
Merit Medical Systems0.31
Raven Industries0.28

1 Includes dividends

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

Core-Mark Holding Company-0.21
Matrix Service-0.20
Team-0.20
SEACOR Holdings-0.17
Tejon Ranch-0.14

2 Net of dividends

Current Positioning and Outlook

In addition to increasing our weighting in select healthcare companies, we made a number of other changes to the portfolio. After an extended period of disappointing results, we have been reducing our weighting in retailers as we see an industry with substantial challenges ahead of it. On the brighter side, we trimmed several long-term winners in Information Technology and Industrials where valuations no longer merited high weightings in the portfolio. Along with healthcare, we have been redeploying some of these assets in banks, where we have sought to take advantage of relatively weak first-half performance.

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

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR 30YR 40YR
Pennsylvania Mutual 3.224.8123.17 4.54 11.68 5.93 9.19 9.91 10.32 13.09
Russell 2000 2.464.9924.60 7.36 13.70 6.92 9.19 7.98 9.03 N/A

Annual Operating Expenses: 0.93

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 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 it's investment 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 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: Coherent was 0.9%, IPG Photonics was 0.8%, Cognex Corporation was 0.7%, Merit Medical Systems was 1.0%, Raven Industries was 1.1%, Core-Mark Holding Company was 0.5%, Matrix Service was 0.0%, Team was 0.3%, SEACOR Holdings was 0.4%, Tejon Ranch 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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