RYPRX Update & Outlook—Royce
article 05-01-2020

Premier Quality—An Update and Outlook

We recently asked Lead Portfolio Manager Chuck Royce and Portfolio Managers Lauren Romeo, CFA and Steven McBoyle for an update and the latest outlook for our Small-Cap Premier Quality Strategy that Chuck has been managing since 1991.

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How did the Small-Cap Premier Quality Strategy perform in 1Q20?

Chuck Royce Royce Premier Fund, the mutual fund we manage in this strategy, was down 27.8% in the first quarter. We were pleased that in this very difficult period the Fund lost less than its small-cap benchmark—the Russell 2000 Index fell 30.6%, which was its worst quarterly performance ever. This quarterly outperformance also helped Premier to beat its benchmark over the trailing one-, three-, five-, 10-, 15-, 20-, 25-year, and since inception (12/31/91) periods ended in March.

Steven McBoyle I think the portfolio’s outperformance in the first quarter was that much more impressive because investors rushed out of stocks in economically cyclical areas, perhaps bracing for an impending recession. That mad rush led to defensive stocks outperforming the cyclical areas we typically favor. So the portfolio’s more than 90% weighting in cyclical stocks at the start of the quarter created a meaningful headwind to returns—but fortunately our high-quality focus more than compensated.

What factors helped give the portfolio its advantage versus the Russell 2000?

Lauren Romeo We were pleased with the strong stock selection during the quarter, which drove all of the fund’s relative outperformance. Our largest relative sector contribution came from Financials where we were close to equal weight but significantly outperformed the index (-4.3% vs. -34.7%). Our longstanding avoidance of banks and mortgage REITs, which lagged, helped, but stock selection mostly drove outperformance in the sector. Two capital markets holdings—Virtu Financial and Ares Management were notable relative outperformers. Consumer Discretionary was another important source of outperformance. This sector contains businesses that were particularly hard hit by COVID-19 driven closures, so our low absolute weight and relative underweight insulated us from the severe stock price declines in industries such as hotels, restaurants & leisure, specialty retail, and textiles, apparel & luxury goods. Additionally, our three Consumer Discretionary holdings outperformed the index.

Which sectors and industries hurt relative performance in 1Q20?

CR Health Care was the largest source of our relative underperformance. Although our holdings did relatively better, their stronger performance couldn’t overcome our large underweight in the sector. Health Care held up better than most sectors in small-cap, boosted by biotechnology, where we had no exposure. Utilities was a similar story—a relatively strong defensive sector where we had no holdings in the first quarter and which was the best—that is, the least bad—performing sector in the index, as it often is in steep declines.

Sectors RYPRX(%) Russell 2000 (%)
Industrials  36.4 15.2
Information Technology 23.6 15.1
Financials 15.6 16.8
Materials  9.9 3.4
Health Care 5.9 21.3
Consumer Discretionary 4.0 8.7
Energy 3.4 1.7
Real Estate 1.1 7.6
Consumer Staples 0.5 3.4
Utilities -- 4.5
Communication Services -- 2.3
Cash and Cash Equivalents -0.3 --

How have you been investing through the decline?

SM We’ve been leaning mostly toward select, high-quality cyclical companies in order to position the portfolio for the eventual recovery. These are the kinds of businesses that look most capable of rebounding to us. We’re mostly looking at those that appear best positioned to participate in, and therefore benefit from, long-term secular trends—those that, while currently interrupted, are likely to reemerge with strength.

In all of these areas, we’re aiming to increase our holdings in companies where we see adaptability, differentiation, and financial strength. These are all hallmarks of high quality in our view.

Did you add any new holdings in the first quarter?

LR We added six new holdings, which is more than we typically do, because the bear market has given us some really promising opportunities to buy what we think are high-quality companies at attractive prices. ESCO Technologies is a multi-line industrial focused on niche markets with favorable long-term demand dynamics. Its most attractive segments are Aerospace & Defense, where it makes highly engineered filtration and fluid flow products, and Utility Solutions, where its products and services include testing instruments, software, and data solutions used for their extensive grid asset base.

SM We also bought shares in two companies that we’ve owned previously in the portfolio, Cirrus Logic, a fabless semiconductor company that develops audio and voice IC and software solutions for mobile communications, automotive entertainment, and consumer audio applications. Additionally, Premier returned to Haemonetics which produces automated blood processing systems and related consumables that are used in surgical blood salvage, blood component collections, and plasma collections. We think the firm’s new leadership and fresh strategies can pave the way for renewed success for its business.

Rogers Corporation is a new name in Premier, though it’s one that we have been following for a long time. Rogers designs and manufactures high specification, very reliably engineered materials for a diverse set of industries. While often viewed as a technology company, Rogers is actually a specialty chemicals company serving high-growth, niche applications, including 5G wireless base stations, ADAS (advanced driver assistance systems) and EV/HEV (electric and hybrid electric vehicles.)

LR Another addition was Inter Parfums, a business that we’ve owned in other portfolios, which is common for many of our Premier holdings. The company develops and markets prestige fragrances under exclusive brand licenses and owned brands such as Montblanc, Jimmy Choo, Coach, and Guess. Its strong track record has been driven by consistent sales growth—through new product launches supported by robust advertising—and proven global sourcing and distribution capabilities. These strategies have established the company as one of a handful of go to outsourcing partners for fashion companies seeking to further monetize their brand equity.

Finally, we added Forrester Research an independent technology research firm that companies use to understand how business technologies are evolving, evaluate which ones to buy, and leverage those investments to improve customer experience and retention. Forrester is an asset-light, high margin business with about two-thirds of its revenue recurring from annual research subscriptions and executive leadership boards. The business has room for meaningful margin expansion if management can accelerate sales growth through product cross-selling and an expanding sales force.

Why do you think this Strategy is well suited for both the current environment and a recovery?

CR I think that an important, and often overlooked, attribute is one that Steve mentioned earlier: adaptability. This is a key differentiator among high-quality companies, but its importance is usually less visible in calmer periods. Companies that have well-defined, effectively defended market niches and strong balance sheets possess the necessary resources to take action in times of uncertainty. The management groups we prefer to invest with have a history of thinking about and acting on more long-term concerns when their competitors are often focused on the short terms. It’s much easier to think long term when you don’t have a highly leveraged balance sheet going into a recession. These are the advantages that we have seen high-quality companies demonstrate over time. Our high-quality focus helped in the downturn and we think the portfolio’s cyclical tilt should be equally beneficial in the recovery.

 

ROYCE PREMIER FUND

 

Important Disclosure Information

Average Annual Total Returns as of 3/31/20 (%) 

  2Q201 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Premier -27.80 -16.45 0.22 3.01 7.04 7.52 9.04 10.38 12/31/91
Russell 2000 -30.61 -23.99 -4.64 -0.25 6.90 5.71 5.28 8.07 N/A

Annual Operating Expenses: 1.19

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 www.royceinvest.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.

Mr. Royce’s, Mrs. Romero’s, and Mr. McBoyle’s thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.

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.

Percentage of Fund Holdings As of 3/31/2020 (%)

  Royce 
Premier Fund

Virtu Financial

0.0

Ares Management CI.A

2.8

ESCO Technologies

1.5

Cirrus Logic

1.3

Haemonetics Corporation

1.9

Rogers Corporation

1.3

Inter Parfums

0.5

Forrester Research

0.8

Company examples are for illustrative purposes only. This does not constitute a recommendation to buy or sell any stock. There can be no assurance that the securities mentioned in this piece will be included in any Fund’s portfolio in the future.

Cyclical and Defensive are defined as follows: Cyclical: Communication Services, Consumer Discretionary, Energy, Financials, Industrials, Information Technology, and Materials. Defensive: Consumer Staples, Health Care, Real Estate, Utilities.

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.

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. All indexes referenced are unmanaged and capitalization-weighted. The Russell 2000 Index is an index of domestic small-cap stocks that 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.

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. The Fund also generally invests a significant portion of its assets in a limited number of stocks, which may involve considerably more risk than a more broadly diversified portfolio because a decline in the value of any one of these stocks would cause the Fund's overall value to decline to a greater degree. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund may invest up to 25% of its net assets (measured at the time of investment) in securities of companies headquartered in foreign countries, which may involve political, economic, currency, and other risks not encountered in U.S. investments. (Please see "Investing in Foreign Securities" in the prospectus.)

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