Royce Special Equity Fund Manager Commentary
article 06-30-2019

Royce Special Equity Fund Manager Commentary

Although the Fund underperformed its benchmarks during the first half of 2019, we like what we own and remain optimistic about the future results for the strategy.

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Fund Performance

Royce Special Equity Fund rose 4.6% for the year-to-date period ended June 30, 2019, trailing its small-cap benchmarks, the Russell 2000 and Russell 2000 Value Indexes, which advanced 17.0% and 13.5%, respectively, over the same period. Much of this underperformance was the result of ineffective stock selection and sector allocation, as investors largely ignored those companies and industries that we like best. Below, we detail how we think this can change. 


The more dovish Fed stance that resulted in lower interest rates has not created any real economic benefits, and this has boosted growth stocks. The Fed’s pivot also caused a record drop in volatility. We have on occasion shared information about how the portfolio has underperformed when volatility is low and done better when it is high. Additionally—and likely related to these factors—for the quarter, year-to-date, and one-year periods ended June 30, 2019, investors favored fast-growing companies, which are underrepresented in our portfolio because of our exacting valuation constraints.


What Worked … And What Didn't

Five of the Fund’s eight equity sectors finished the first half in the black. Information Technology made by far the biggest positive contribution, with Industrials and Consumer Staples following. While its negative impact was comparatively small, Communication Services detracted most, followed by even more modest detractions from Real Estate and Energy. With the market’s strong rebound, the Fund’s cash level again rose during the first half in light of what we saw as elevated valuations throughout much of the asset class.


Snack food company John B. Sanfilippo & Son was the biggest positive contributor at the position level, followed by Computer Services—which offers bank, payment processing, and related services—and Hubbell Incorporated, which manufactures, designs, and sells electrical and electronic products. Children’s publishing company Scholastic Corporation was the top detractor, followed by supermarket operator Weis Markets, diversified manufacturing company National Presto Industries, and furniture maker Hooker Furniture. 



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Ineffective stock selection drove underperformance relative to the Russell 2000 in the first half of 2019, though sector allocation also detracted. Consumer Discretionary hurt results most, largely due to poor stock picking in household durables and auto components as well as our larger sector exposure. Industrials also hampered results, largely due to poor stock selection in aerospace & defense. The media group in the Communications Services sector was another notable source of underperformance while the portfolio received a relative advantage from our lack of exposure to Financials, which lagged the Russell 2000 as a whole. Our lack of exposure to Utilities was a second source of outperformance, albeit a very modest one.



Top Contributors to Performance Year-to-Date Through 6/30/191 (%)

John B. Sanfilippo & Son1.73
Computer Services1.47
Hubbell Incorporated1.37
AVX Corporation0.66
Winnebago Industries0.59

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/192 (%)

Scholastic Corporation-0.85
Weis Markets-0.75
National Presto Industries-0.57
Hooker Furniture-0.53
Marcus & Millichap-0.27

2 Net of dividends

Current Positioning And Outlook

The state of our economy remains the center of attention. Most forward-looking measures are flashing at least yellow. The lack of inflation clearly remains a major concern for the Fed. The core personal consumption expenditures (PCE) price index—the Fed’s favorite indicator of inflation—is running at 1.5%. The U.S. is not alone; other central banks have remained accommodative with the result that $13 trillion of negative yielding debt is currently outstanding. While virtually all asset classes seem richly priced, lower interest rates could allow them to climb higher until the day of reckoning arrives. Excess liquidity is driving asset prices up again. Volatility has been low, and speculators are betting on this continuing. The current sentiment is similar to January and September of 2018 before market declines—more evidence of the complacency that’s so common these days. We must remember that if the economy experiences a substantial downturn, policymakers are starting from a weaker position in terms of response. They’ve already used rate and tax cuts to little or no avail.


We believe that more fiscal actions, such as infrastructure spending and targeted tax incentives for housing or automobile purchases, are necessary to help the economy grow, make interest rates rise, and push inflation higher. These actions would also have a potentially positive impact on our portfolio. We see two other potential catalysts for higher returns. The first would be if the economy continues its modest growth track. Profit margins would come under pressure as they are already at all-time highs, and most if not all costs that could be removed were removed following the Great Financial Crisis. In this modest growth environment, we would likely see more intra-industry transactions. Our holdings would be prime targets as we believe they offer incremental earnings due to their low valuation, synergistic opportunities to improve earnings, and (unique to our holdings) the ability of the acquirer to use the strength and resources of our holdings to finance their own acquisition. The second would be a move toward tightening regulations regarding the use of non-GAAP earnings. If the Public Companies Accounting Oversight Board (PCAOB) and the SEC were to restrict the use of this pernicious form of reporting and implementation, we believe our portfolio would benefit because investors would seek out non-abusers such as our holdings. (Something similar occurred in 2002 after the Enron episode.) We like what we own and remain optimistic about the future results for the strategy.

Average Annual Total Returns Through 06/30/19 (%)

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Special Equity -2.884.59-5.427.473.539.666.899.258.46 05/01/98

Annual Operating Expenses: 1.18

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. 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, 2019, 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, 2019 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 6/30/19, the percentage of Fund assets was as follows: John B. Sanfilippo & Son was 5.6%, Computer Services was 4.9%, Hubbell Incorporated was 5.7%, AVX Corporation was 3.3%, Winnebago Industries was 1.3%, Scholastic Corporation was 4.4%, Weis Markets was 2.9%, National Presto Industries was 3.3%, Hooker Furniture was 2.0%, Marcus & Millichap was 3.5%


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 2500 is an unmanaged, capitalization-weighted index of the 2,500 smallest publicly traded U.S. companies in the Russell 3000 index. The returns for the Russell 2500-Financial Sector represent those of the financial services companies within the Russell 2500 index. Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. The MSCI ACWI ex USA Small Cap Index is an index of global small-cap stocks, excluding the United States. Index returns include net reinvested dividends and/or interest income. 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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