Royce Small-Cap Value Fund Manager Commentary
article 06-30-2018

Royce Small-Cap Value Fund Manager Commentary

With the expectation of increased volatility, we see a reasonable environment for our contrarian value approach taking shape.

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Fund Performance

Royce Small-Cap Value Fund rose 7.1% for the year-to-date period ended June 30, 2018, narrowly trailing its small-cap benchmark, the Russell 2000 Index, which was up 7.7% for the same period. The Fund narrowly outpaced the small-cap index, however, for the one-year period ended June 30, 2018, up 17.7% versus 17.6%.

What Worked… And What Didn’t

Information Technology and Consumer Discretionary were the top-contributing sectors by a wide margin, while Utilities, where we typically have very little exposure, detracted modestly. The portfolio’s two leading industry groups—electronic equipment, instruments & components and specialty retail—came from its two top-contributing sectors. The airlines group detracted most at the industry level, followed by commercial services & supplies—both groups are in the Industrials sector.

Three of the portfolio’s top five positive contributors came from the electronic instruments & components industry. Two more top-10 holdings from that same group—Vishay Intertechnology, which makes semiconductor and passive component equipment, and Celestica, a contract manufacturer that offers manufacturing, hardware platform, and supply chain solutions—were also strong performers. Another contract manufacturer, Fabrinet specializes mostly in optical components. Its shares tend to be highly volatile, so we always try to trade effectively around its occasionally extreme moves. The company’s recent growth has been strong, spurred by the ongoing adoption of cloud storage solutions, which require optical components. Insight Enterprises and PC Connection are value-add distributors that provide a wide range of IT products and solutions. Global demand has been on the rise, which has kept revenues and earnings for both companies healthy.

Moving from tech to transportation, the portfolio also saw a strong contribution from Stoneridge, a manufacturer of highly engineered electrical and electronic components, modules, and systems for the commercial vehicle, automotive, and agricultural vehicle markets. New management, which joined the firm a few years ago, has rolled out new products, including MirrorEye, a camera monitor system that replaces the rear- and side-view mirrors on trucks. In May, the company reported increased 2018 guidance for sales and adjusted earnings per share while also reaffirming previous margin estimates. All of this combined to keep its shares rolling.

Asset management business Federated Investors detracted most at the position level, as outflows from a large equity mutual fund as well increased competition in money market funds helped to keep investors selling. We chose to hold our shares in the expectation that the firm will be able to rebound. We built our position in low-cost carrier Spirit Airlines, one of three holdings in the airline industry that disappointed in the first half. Spirit saw weakness in fares, to which its stock has historically been vulnerable, through much of 2018’s first six months. We like its profitability and long-term prospects and were also encouraged by a recent reversal in the direction of fares. We also chose to hold our position in truck trailer manufacturer Wabash National in the first half. The company reported strong overall demand and greater-than-anticipated new trailer shipments in April, but earnings were short of expectations, which drove its stock price down.


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LATEST PORTFOLIO + PERFORMANCE INFO

 

First-half performance versus the benchmark suffered most from sector allocation—stock selection was a strength against the Russell 2000. The portfolio’s much lower weighting in Health Care, the top performer in the Russell 2000, hurt most, while ineffective stock selection in Financials, particularly in the capital markets and insurance industries, also had a negative impact, as did our greater exposure to Industrials, largely due to our overweight in airlines, where, in addition to Spirit, Allegiant Travel and Hawaiian Holdings also disappointed. Stock selection strength could be seen in a number of sectors, with the largest positive impact coming from holdings in Consumer Discretionary, with notable outperformance in the auto components industry. Holdings in Consumer Staples and Real Estate also contributed positively to relative results in the first half, with our lower weighting in the latter sector also helping.


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

Fabrinet0.75
Stoneridge0.73
Insight Enterprises0.63
PC Connection0.62
Village Super Market Cl. A0.52

1 Includes dividends

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

Federated Investors Cl. B-0.77
Spirit Airlines-0.40
Wabash National-0.29
Electro Scientific Industries-0.26
Kimball International Cl. B-0.24

2 Net of dividends

Current Positioning and Outlook

As interest rates continue to rise—and rise more consistently—valuations become more and more important. Most looked high to us at the end of June, especially with current and imminent challenges, some of which investors may be overlooking. In addition to a flattened yield curve and trade war noise, we have a more challenging climate for earnings growth now that the tax cuts have been reflected and a lack of quality in earnings can be discerned in many cases throughout the small-cap market. The approaching mid-term elections could generate a great deal of noise—and market volatility—all on their own. So while in general we see more that is worth selling than buying, we have also seen pockets of value within technology in semiconductor and capital equipment makers, distributors, and contract manufacturers, as well as in banks. Moreover, with the expectation of increased volatility, we see a reasonable environment for our contrarian value approach taking shape.

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

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR SINCE INCEPT. DATE
Small-Cap Value 7.657.1117.716.147.305.6110.209.74 06/14/01
Russell 2000 7.757.6617.5710.9612.4610.6010.508.73 N/A

Annual Operating Expenses: Gross 1.51 Net 1.49

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 www.roycefunds.com. Gross operating expenses reflect the Fund's total gross annual operating expenses and include management 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, 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, 2019.

All performance and risk information presented in this material prior to the date of commencement 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, 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: Fabrinet was 2.0%, Stoneridge was 1.1%, Insight Enterprises was 2.5%, PC Connection was 2.5%, Village Super Market Cl. A was 2.0%, Federated Investors Cl. B was 1.4%, Spirit Airlines was 2.3%, Wabash National was 2.0%, Electro Scientific Industries was 1.5%, Kimball International Cl. B was 1.3%, Vishay Intertechnology was 2.2%, Celestica was 2.2%, Allegiant Travel was 1.5%, Hawaiian Holdings was 2.0%


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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