RYSEX Update & Outlook—Royce
article 04-20-2020

Special Equity—An Update and Outlook

We recently asked Portfolio Manager Charlie Dreifus for an update and outlook for the Small-Cap Special Equity Strategy that he’s been managing at Royce since 1998.


How did the Small-Cap Special Equity Strategy perform in 1Q20?

The mutual fund I manage in the strategy, Royce Special Equity, was down 24.6% in the first quarter. The Fund lost less than both of its small-cap benchmarks—the Russell 2000 Index fell 30.6% (for the worst quarterly performance in its history) while the Russell 2000 Value Index was down 35.7%. The Fund has a long history of superior down market performance, which has been helped by having very stringent quality standards, particularly for pristine balance sheets.

Down Market Performance Comparison (%)


So these attributes served the Fund well once again, this time through one of the fastest and most alarming downturns small-cap stocks have ever been through, as companies with higher leverage fell further.

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

The Fund’s relative outperformance came from both stock selection and sector allocation in the first quarter. The former had the bigger positive impact, which pleases me. A solid share of our relative advantage came from better stock selection in Industrials—one of our larger sector weights—and our lack of exposure to Energy, which was the worst-performing sector in the Russell 2000 by a wide margin in 1Q20. The Fund’s cash holdings also provided an edge versus the small-cap benchmark.

Positions % Of Net Assets
(Subject To Change)
Computer Services 6.6 Information Technology
Standard Motor Products 5.8 Consumer Discretionary
Marcus & Millichap 5.1 Real Estate
Hubbell Incorporated 4.9 Industrials
Scholastic Corporation 4.5 Communication Services
National Presto Industries 3.9 Industrials
Huntsman Corporation 3.5 Materials
Kulicke & Soffa Industries 3.4 Information Technology
Gentex Corporation 3.2 Consumer Discretionary
Johnson Outdoors Cl. A 3.1 Consumer Discretionary

We were hurt somewhat by having no exposure to Health Care, which held up relatively well within small-cap, as well as some ineffective stock selection in Communication Services and lack of exposure to Utilities. Throughout the Fund’s history, which goes back to 1998, we’ve had low exposure to Utilities and Health Care stocks.

How have you been investing through the decline?

Given these difficult circumstances, I’m staying patient until there is greater clarity and more conviction in the economic, revenue, and profit outlook. I draw on my 52 years of experience. The approach I’ve taken ever since the first bear market I invested through—the “Nifty Fifty” downturn in 1973-74—is to dollar cost average. Declines often go on for extended periods, so I buy more when prices fall. This has served me and, more important, my investors, well over the years.

Of course, in these times, with no visibility into current earnings levels, I go back to my other hallmark metrics—low leverage, high free cash flow and cash conversion, and high return on investment, coupled with clean accounting and governance. And these attributes are even more critical in the current environment. I don’t know any more than anyone else does about how long the pandemic will last or what the ultimate effects will be. What I do know is what makes for quality, durability and survival in a company. I buy businesses that I think will not only make it through whatever comes next in these difficult days, but that also have the strength to be opportunistic during times like this.

What is your outlook on the market?

I don’t see market volatility subsiding until the number of coronavirus cases has peaked on a global level, and the confirmation of that peak is evidenced. Only then will we be able to chart the damage done to the economy and thus have some idea of what revenues and earnings might look like for individual companies (though still fraught with the possibility for huge errors). History also suggests that pandemics come in waves, so in the months to come, certainly by summer, investors will also need to incorporate that potential risk into their expectations.

All of this notwithstanding, it’s important to remember that when the stock market has a sale, it scares away the shoppers. One has to have a disciplined plan to execute on the sale price offerings, as I do. Equally important is the point that investing during frightening times can enhance future returns if one is prepared and if one has a proven strategy to benefit from the turmoil. For example, investors are paying much less today for a slice of future earnings than they did just seven weeks ago. The less one pays for future earnings, the more one should earn. It is really that simple.




Important Disclosure Information

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

Special Equity -24.62 -21.16 -6.09 -1.35 4.85 5.26 8.48 7.13 05/01/98
Russell 2000 -30.61 -23.99 -4.64 -0.25 6.90 5.71 5.28 5.43 N/A
Russell 2000 Value -35.66 -29.64 -9.51 -2.42 4.79 4.11 6.83 5.56 N/A

Annual Operating Expenses: 1.18

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. Dreifus’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.

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 Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. 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. The Fund invests primarily in small-cap stocks which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) As of 03/31/20, the Fund invested a significant portion of its assets in a limited number of stocks, which may involve considerably more risk than 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.)



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