Royce Total Return Fund Manager Commentary
article 06-30-2019

Royce Total Return Fund Manager Commentary

Our Dividend Value Strategy underperformed its index, but the Fund’s historic pattern of generating positive relative results during difficult periods was evident in the trailing one-year period.

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Fund Performance

For the year-to-date period ended June 30, 2019, Royce Total Return Fund rose 15.3%, trailing the Russell 2000 Index, which was up 17.0% for the same period. In contrast, Total Return’s historic pattern of delivering better relative returns in difficult periods for stocks was evident in the trailing one-year period, when the Fund advanced 0.4% while the small-cap index declined 3.3%.


What Worked… And What Didn't

At the end of June, Financials and Industrials were the portfolio’s biggest sectors, accounting for more than half of its total assets. Unsurprisingly, then, they were the top-contributing sectors for 2019’s first half—and by a wide margin, leading 10 of the Fund’s 11 equity sectors that made positive impacts on performance. Only Communication Services detracted from results—and did so marginally—while Consumer Staples and Health Care made the smallest contributions. All three were among our lowest sector weightings at the end of June.

The industries which made the three biggest positive contributions came from Financials—capital markets, the portfolio’s second-largest industry weighting at the end of June; insurance, its third largest; and banks, its biggest. Following these, four of the next five top-contributing industries were in Industrials—machinery, commercial services & supplies, aerospace & defense, and professional services. We were pleased to see such widespread strength from mostly cyclical areas, many of which did best in the more volatile second quarter, a period that also saw dividend-paying small-caps outpace non-dividend payers, 3.2% versus 1.0%. Detractions at the industry level were modest in comparison and included only eight groups. Specialty retail (Consumer Discretionary), diversified telecommunication services (Communication Services), road & rail (Industrials), and distributors (Consumer Discretionary) detracted most. Their combined effect, however, was decidedly modest. 


Similarly, individual positions that detracted made a comparatively minor impact on performance. Lancaster Colony produces specialty foods and other products for the retail and food service markets. While sales and earnings remained positive in the first half, expectations were for fatter margins and higher earnings. Its shares fell most precipitously in January following the announcement of fiscal second-quarter results. We reduced our stake in the first half. Agricultural equipment supplier Lindsay Corporation was the only one of the portfolio’s 19 machinery holdings to finish the first half in the red. The company faced several challenges, including lower farming incomes that have crimped capital spending and led to ongoing weakness in its core market, excess rainfall and flooding in the Midwest, and tariff and trade war woes. In early July, however, Lindsay noted an uptick in domestic irrigation sales, while recent improvement in key crop prices such as corn have improved agricultural sentiment. We trimmed our stake slightly in the first half.


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The Fund’s top contributor at the position level was Erie Indemnity, a property and casualty insurer with an attractive and uncommon corporate structure. Erie Insurance Exchange, an affiliated policyholder-owned company, issues and owns the policies, while Erie Indemnity provides management services to the Exchange. This gives it little direct liability, so it has low capital requirements and high returns on capital. Erie’s stock advanced steadily through the first half year as the company reported consistent growth and expanding margins. HEICO Corporation, which manufacturers replacement aerospace parts, saw its shares reach higher altitudes in June, after the company reported strong organic sales and expanding margins, boosted by strength in its flight support and electronics segments. These developments led HEICO to raise guidance for the rest of the year.


The Fund lagged its benchmark mostly due to sector allocation, though stock selection was also slightly negative in the first half. Information Technology detracted most as both our underweight and stock selection miscues hampered relative results in this top-performing sector, where dividend-paying companies are scarce in many areas. Our overweight in Consumer Staples, along with some lagging stock selection in the food products industry, detracted from relative returns, though to a lesser degree, as did stock selection in Consumer Discretionary. The largest source of outperformance in the year-to-date period came from Financials and was entirely due to superior stock selection, as overweighting this sector detracted. Health Care also contributed positively—and quite modestly—to relative results.



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

Erie Indemnity Cl. A1.49
HEICO Corporation0.71
Ares Management Cl. A0.65
ManpowerGroup0.53
Cohen & Steers0.34

1 Includes dividends

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

Lancaster Colony-0.15
Lindsay Corporation-0.13
ATN International-0.12
ArcBest-0.11
Caleres-0.10

2 Net of dividends

Current Positioning And Outlook

Markets are very good at surprising most investors. Today, given widespread concerns about slowing growth, increasing trade tensions, and the extended economic cycle, the most surprising outcome might be a rally. We see four favorable factors in the current market environment—low inflation, modest valuations, moderate growth, and increasing liquidity. When taken together, we see these factors as painting an attractive picture for small-cap investors. With so much attention on negative macro issues, we think investors may be missing this positive picture. We see highly promising select opportunities in dividend-paying small-cap cyclicals, particularly in Financials, Industrials, and Materials.

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

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Total Return 3.4015.320.369.955.7411.837.729.0610.40 12/15/93
Russell 2000 2.1016.98-3.3112.307.0613.458.157.778.91 N/A

Annual Operating Expenses: 1.20

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, 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, 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: Erie Indemnity Cl. A was 2.8%, HEICO Corporation was 1.6%, Ares Management Cl. A was 1.7%, ManpowerGroup was 0.8%, Cohen & Steers was 1.0%, Lancaster Colony was 0.4%, Lindsay Corporation was 0.7%, ATN International was 0.6%, ArcBest was 0.4%, Caleres was 0.3%


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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