Royce Special Equity Multi-Cap Fund Manager Commentary
article 06-30-2017

Royce Special Equity Multi-Cap Fund Manager Commentary

The portfolio embodied A Tale of Two Quarters in the first half, at least when compared to its benchmark.


Fund Performance

Royce Special Equity Multi-Cap Fund posted a solid absolute performance in the first half while trailing on a relative basis. The Fund increased 5.9% for the year-to-date period ended June 30, 2017 versus a 9.3% gain for its large-cap benchmark, the Russell 1000 Index, for the same period.

The portfolio embodied A Tale of Two Quarters, at least when compared to its benchmark. For the first quarter, the Fund experienced the same lofty returns as most large-cap stocks—even more so, actually—and outpaced the Russell 1000, advancing 7.0% compared to 6.0% for the benchmark. Considering the strength in the first quarter of Information Technology, where we were underweighted, and Health Care, where we had no exposure, this was an especially gratifying outcome. Helping most were terrific results from Apple (the Fund’s top contributor in the first half) and, to a lesser extent, motion control products maker Parker Hannifin. There were also mostly minor losses from detractors, the largest of which was retailer Dicks Sporting Goods, 2016’s top contributor.

The second quarter, on the other hand, saw less stellar results from contributors accompanied by further share price declines for Dicks and an impactful loss for industrial supplies distributor W.W. Grainger. The result was a loss of 0.9% for the Fund in the second quarter while the Russell 1000 climbed 3.1%. We were pleased, however, that Special Equity Multi-Cap outperformed the large-cap index for the one-year period ended June 30, 2017. The Fund’s average annual total return since inception (12/31/10) was 10.0%.

What Worked… And What Didn’t

Four of the Fund’s six equity sectors finished the first half in the black, with Industrials leading by a substantial margin and Information Technology also making a notable contribution. Of the two sectors that detracted, Consumer Discretionary made the largest negative impact, thanks to disappointing results from Dicks Sporting Goods. While we are all too aware of the challenges facing retailers in the age of Amazon, we thought highly enough of the company’s long-term prospects to hold a large stake at the end of June.

The last 12 years were characterized by central banks providing ample liquidity and keeping rates low. Barron’s recently referenced some compelling data on the period compiled by the University of Chicago’s Eugene Fama and Dartmouth College’s Kenneth French: For the 12 years ended April 30, 2017, value stocks underperformed growth by an annualized average of 0.7%. This was contrasted with the prior eight decades, going back to 1926, in which value outperformed growth by an average of 4.8% a year. The only other 12-year span since 1926 when value underperformed growth was the 12-year period ended March 31, 2000. We suspect that those who ignore this history, and its related force of mean reversion, invest in expensive growth at their peril.

Much has been written about the low volatility in the current market. What has not received as much attention is its impact on drawdowns. We have seen a quiet market with a clear upside bias. The maximum drawdown for the S&P 500 in the first half of 2017 topped out at 2.8%, the second-smallest first-half in 89 years. Investors are simply far too comfortable in our view. We would ask whether the macro picture is currently so inviting as to justify this placidly positive mood. We certainly don’t believe it is and would hasten to add that complacency usually engenders negative outcomes. The Nasdaq 100 Index posted a larger number of higher daily closes only once before other than 2017—in 1999. This is not a good history in our estimation.

Relative to the Russell 1000, the Fund suffered most in the first half from stock selection in Consumer Discretionary (thanks again to Dicks Sporting Goods). Our lack of exposure to the rebounding Health Care sector as well as the portfolio’s cash position were also drags on relative results. Conversely, the Fund’s lack of exposure to both correcting Energy stocks and Telecommunication Services companies was a plus, as was stock selection in Industrials, where global staffing and services company ManpowerGroup stood out.

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

Illinois Tool Works1.32
Parker Hannifin0.97

1 Includes dividends

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

Dicks Sporting Goods-1.72
Grainger (W.W.)-0.74
Carlisle Companies-0.26

2 Net of dividends

Current Positioning and Outlook

Stocks advancing on the prospect of economic growth is inconsistent with declining bond yields that suggest a weaker outlook. Only one of these views can be right. Investors thus far seem willing to pay up for the shares of companies that they believe can continue to do well even if the overall outlook may be saying otherwise. The favored issues this year have had perceived growth at rates much more vibrant than the tepid outlook for the economy. A more refined approach—and dare we say a potentially more rewarding one?—might be companies that have the capacity and willingness to grow their dividends.

We continue to believe that the world is both yield conscious and yield undernourished and think that an aging population with expectations of a longer retirement period will exert downward pressure on yields. We also suspect that this hunger, coupled with likely low absolute rates for the foreseeable future, portends a likely revolution of companies that will be raising their dividends. This remains a key component of our search. We think growing income scarcity is just as important as scarcity in revenue and earnings growth, perhaps even more so.

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

Special Equity Multi-Cap -0.945.9521.042.5710.149.96 12/31/10

Annual Operating Expenses: Gross 1.39 Net 1.24

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.

All performance and risk information presented in this material prior to the commencement date of Investment Class shares on 3/1/12 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, 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: Apple was 10.1%, Illinois Tool Works was 7.3%, Parker Hannifin was 5.1%, ManpowerGroup was 2.3%, McDonald's was 3.0%, Dicks Sporting Goods was 5.6%, Grainger (W.W.) was 3.1%, Avnet was 2.2%, Carlisle Companies was 2.4%, Snap-on was 3.7%.

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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