Royce Total Return Fund Manager Commentary
article 06-30-2017

Royce Total Return Fund Manager Commentary

A challenging first half offered a narrower, growth-driven market with very low levels of volatility—not an ideal environment for small-cap dividend payers.


Fund Performance

Royce Total Return Fund gained 2.8% for the year-to-date period ended June 30, 2017, behind its small-cap benchmark, the Russell 2000 Index, which was up 5.0% for the same period. Unlike 2016, a year in which both small-cap dividend payers and value stocks enjoyed higher relative returns, the first half of 2017 offered a narrower, growth-driven market that also featured very low levels of volatility. Against this backdrop, results for our dividend-focused value approach were not surprising.

The Fund rose 2.2% in the first quarter versus 2.5% for the Russell 2000, a respectable result in light of the generally underwhelming results for value stocks. The second quarter proved difficult for several holdings in both consumer sectors as well as certain positions in the industrial space, while the portfolio’s substantially lower exposure to resurgent Health Care stocks was also a factor. The Fund was up 0.5% in the second quarter versus 2.5% for the small-cap index. Longer-term results were stronger on both an absolute and relative basis.

Total Return outperformed the Russell 2000 for the 20-year and since inception (12/15/93) periods ended June 30, 2017. The Fund’s average annual total return since inception was 10.8%.

What Worked…And What Didn’t

Seven of the Fund’s 11 equity sectors made positive contributions to first-half results. Driven by strength in the capital markets and insurance industries, Financials led by a wide margin. For many years one of the Fund’s largest sectors, financial companies offer great diversity in terms of business models, and many stocks in the sector also boast long dividend-paying histories.

The sector’s top contributor in the first half of 2017 was Canadian investment and insurance business E-L Financial, which benefited from increases in net investment income, assets under management, and profits from wealth management.

Other industries that did well in the first half included chemicals (Materials) and professional services (Industrials). The top-contributing holding was global staffing and services company ManpowerGroup, whose stock was helped by improved topline growth and a strong bottom line in 2016, solid fiscal first-quarter 2017 earnings, and a brightening global employment picture. Teleflex provides medical technology and devices used for critical care and surgical applications. Two consecutive quarters of better-than-expected earnings helped to draw investors. We initially liked its niche business, solid cash flow, and dividend.

It’s a good example of our conservative, risk-conscious approach to the Health Care sector, where dividends are scarce. Less than 8% of the small-cap companies in the sector paid a dividend at the end of June 2017, which accounts for the sector’s perennial underweight in the portfolio.

Four sectors detracted from first-half results, with Energy and Consumer Discretionary making the biggest negative impacts. The latter sector’s specialty retail group hurt performance most as the industry continues to struggle with secular shifts in consumer spending and behavior. We reduced our exposure by nearly half, selling our shares of holdings such as footwear, headwear, and sports apparel retailer Genesco and car repair and tire services business Monro Muffler Brake.

The top detractor at the position level was SEACOR Holdings, which provides marine transportation equipment and logistics services mostly for the energy and agricultural markets. Its earnings remained pressured by ongoing weakness in the offshore marine vessel business, which was exacerbated by the decline in oil prices in the first half, as well as overcapacity in its inland river barge and tow business. HNI Corporation manufactures office furniture and household products. Its shares slumped due to declining revenues and disappointing earnings in the first quarter. Liking its long-term prospects, we built our stake in the first half.

First-half relative performance suffered most from our significant underweight in Health Care. Both our larger weighting and disappointing results in specialty retail stocks created a disadvantage in Consumer Discretionary. The brightest spot for first-half relative performance came from Financials, where superior stock selection in capital markets and banks (where our underweight also helped) drove the sector’s results. Effective stock selection in the Materials sector was also a relative positive.

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

E-L Financial0.26
Hill-Rom Holdings0.26
Quaker Chemical0.25

1 Includes dividends

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

SEACOR Holdings-0.23
HNI Corporation-0.22
Cato Corporation (The) Cl. A-0.21
Ritchie Bros. Auctioneers-0.13

2 Net of dividends

Current Positioning and Outlook

We reduced our exposure to Consumer Discretionary, not just in the specialty retail group but also in textile, apparel & luxury goods as the ongoing negative effects of e-commerce show no signs of abating. Additionally, we somewhat repositioned the Fund’s weightings in Financials by trimming property & casualty insurers and traditional asset managers in favor of banks and alterative asset managers.

Over the last couple of years, we have been increasingly drawn to non-traditional asset managers, specifically in the alternative asset management space, which we think is an undervalued zone in an asset-light business that is not well understood by other investors. Overall, the portfolio is positioned to benefit from any cyclical upswing, with approximately two-thirds of its assets in Financials, Industrials, and Materials. We also think that its dividend-paying approach may help it to hold up relatively well if the long-awaited small-cap correction occurs in the second half.

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

Total Return 0.542.7819.095.8012.156.248.769.3310.82 12/15/93

Annual Operating Expenses: 1.21

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, 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 its investments 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: ManpowerGroup was 1.6%, Teleflex was 1.1%, E-L Financial was 1.7%, Hill-Rom Holdings was 0.9%, Quaker Chemical was 1.9%, SEACOR Holdings was 0.6%, HNI Corporation was 0.8%, Cato Corporation (The) Cl. A was 0.2%, Genesco was 0.0%, Ritchie Bros. Auctioneers was 0.8%, Monro Muffler Brake was 0.0%.

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 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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