PM Jay Kaplan’s Outlook and Perspective for Total Return | Royce
article , video 07-27-2018

PM Jay Kaplan’s Outlook and Perspective for Total Return

Portfolio Manager Jay Kaplan explains how the market’s behavior is leading him to be more cautious.


What’s your outlook?

My outlook is constructive and cautious. The Russell is making new highs almost every day. The leadership of the Russell 2000 this year continues as it’s been for a while to be in healthcare and technology, mostly in the non-earning companies.

Non-Earners Led YTD
Returns for Companies with Positive Earnings before Interest and Taxes (EBIT) and Negative EBIT 12/31/17-6/30/18


Source: FactSet

The Russell is on track so far this year to have double digit returns. We don’t know what will happen in the second half. But that’s how we’re tracking so far. Because the market’s high, we’ve been taking some profits and trimming around some of our higher multiple long-term winners. But we really do like where we are.

Is market behavior affecting how you’re managing the Portfolio?

The behavior of the market is leading us to be more cautious as interest rates go up. I think interest rates will be headed higher for quite a while. Long duration assets, those companies that don’t earn much now, but are expected to earn way in the future. As they are discounted back with higher rates their valuation should come down. Right now cash generating businesses should do better relatively as rates continue to go up.

What is your perspective on Total Return’s performance this year?

Total Return's performance this year on an absolute basis has been disappointing. We got hurt by a few things this period. We tend to over-index industrials and financials, that’s the history.

Total Return Overweight Financials and Industrials
Sector Weightings for Fund and Index at 6/30/18


Because that’s where the dividends are. Those were two of the worst performing sectors in the Russell, so that didn’t help us. Our stock selection was a little bit disappointing. That didn’t help us. And the performance of the bond proxies, which are the REITs and the utilities, stocks that we usually don’t own a lot of, as the yield curve started to flatten, those did very well, and those are dividend paying stocks that did well, and we had trouble keeping them.

But let me frame it in context of what Total Return strategy really is. Historically, Total Return has exhibited very low volatility. In fact, if you look at the entire universe of small cap funds, all funds value core growth, you’ll find the Total Return is amongst the lowest in volatility.

Low Volatility
5-Year Relative Standard Deviation vs. all Small-Cap Funds tracked by Morningstar as of 6/30/18


The Fund was in the lowest volatility quintile compared with all funds in Morningstar’s Small Growth, Small Blend, and Small Value Categories with at least five years of history, a total of 524 funds as of 6/30/18. The universe consists of each fund’s oldest share class only. Volatility quintiles are based on the average five-year standard deviation for each of the last four calendar quarters. Higher volatility is usually associated with higher risk.

Now there’s trade off that goes along with that. Historically, when markets are very, very strong, we’ve underperformed. 

We don’t expect that these conditions will remain forever. Markets are making all-time highs almost every day. But interest rates continue to go up, and there will be pressure, we think, on the leadership, which has been the non-earning companies, particularly in the areas of biotech and Internet stocks. So we would hope that if history is a guide, when volatility picks up, the Total Return fund can exhibit those historic patterns and do well.

Important Disclosure Information

Average Annual Total Returns (%) as of 6/30/18

Total Return 2.90 0.59 11.23 9.85 9.75 8.70 9.28 9.01 10.83 12/15/93
Russell 2000 7.75 7.66 17.57 10.96 12.46 10.60 10.50 8.03 9.44 N/A
Annual Operating Expenses: 1.21%
1 Not Annualized

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.

The thoughts and opinions expressed in the video are solely those of the persons speaking as of July 9, 2018 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

Frank 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 unmanaged, capitalization-weighted 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 performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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.

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