RYPNX Update & Outlook—Royce
article 04-27-2020

Update And Outlook For Our Small-Cap Deep Value Strategy

Portfolio Manager Bill Hench recently gave us an update and outlook for our Small-Cap Deep Value Strategy.

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How did the Small-Cap Deep Value Strategy perform in 1Q20?

Royce Opportunity Fund, the open-end mutual fund that we manage in the Strategy, fell 37.1% in 1Q20, losing more than both of its small-cap benchmarks. The Russell 2000 Index lost 30.6% while the Russell 2000 Value Index was down 35.7%, which was the worst quarterly performance for both indexes in their histories. The portfolio had a lot of exposure to more economically sensitive cyclical areas—close to 80% of its total assets at the end of March. This played a big role in its underperformance.

What areas hurt most versus the Russell 2000 in 1Q20?

Our quarterly performance was hurt by ineffective stock selection—our sector allocation was slightly positive. A large portion of the relative disadvantage came from stock selection in two sectors—Industrials and Health Care (where our lower weighting also hurt). Another came from the Fund’s larger weighting in Energy stocks during the quarter—Energy was the worst-performing sector in the Russell 2000 by a wide margin in 1Q20. On the other hand, the portfolio’s lower exposure to Real Estate stocks and better stock selection in Communication Services gave us a small relative advantage in the quarter, as did our cash holdings.

What gives you and your team confidence that you can turn this around?

Relative underperformance in significant declines has been common for the Fund historically—it happened in the bear markets in 2000-2002 and 2008-2009. But the Strategy also has a history of strong rebounds in market recoveries. Opportunity Fund outperformed the Russell 2000 during all five of the small-cap trough-to-peak periods since the Fund’s inception in 1996. So we’re hopeful that we’ll see a repeat of this pattern when stock prices begin a sustained comeback.

Up Market Performance Comparison
As of 03/31/20

rof-upmarket

Royce generally defines a trough as the lowest point of a decline of at least 15% from a market peak.

How have you and your team been investing through the volatile bear market?

In many ways, it’s been business as usual. We haven’t changed how we’re evaluating companies. However, our evaluations did lead us to sell a fair amount of names in the early days of the crisis. The assumptions we had made about cash flows and a company’s ability to clean up its balance sheet or other issues that needed to turn around looked very different at the end of March than when we met with the companies and discussed their strategies.

Even more important, the bear market has brought a lot of companies that did not meet our valuation metrics earlier in the year down to levels that we now find attractive. Most of these companies are a good deal bigger than our average market cap, which was a little below $600 million at quarter end. They also tend to have more strength in their balance sheets and better margins. This widespread pull back in share prices, especially in the first two weeks of the decline, really opened up a lot of companies for us to look at that will hopefully be among the positions that lead when prices rebound. So we have some very interesting prospects—a whole new crop of what we think are exciting opportunities.

Are you finding more opportunities in any particular sectors or industries?

We’ve been buying or adding to technology companies that make semiconductors and other components and devices that serve the electronic communication backbone and/or that help with Internet speed, data delivery, and cloud storage. We’ve also been active in various consumer areas, looking at companies that are well capitalized and that appear otherwise capable of picking up where they left off. In Health Care, we still like companies that can bend the cost curve as well as those that look geared to resume profitability when the world returns to a more normal state of affairs.

What is your outlook for the Strategy?

We always see our task as constructing a portfolio of what we believe are attractively inexpensive small-and micro-cap names that we also think can provide high returns over time. The disruptive events that have been pushing prices lower and creating very high volatility should also continue to offer us increased opportunities to achieve that performance goal over the long term. No one knows how long this bear market will last or how low the market will ultimately go. We’re not trying to call a bottom for the market or the companies we own. But we have been through difficult times before—most notably the 2008-09 Financial Crisis—and we’re trying to use those experiences to our clients’ advantage during this difficult time as well.

 

ROYCE OPPORTUNITY FUND

 

Important Disclosure Information

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

  2Q201 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Opportuity -37.14 -29.50 -9.26 -2.69 4.77 4.79 6.90 9.35 11/19/96
Russell 2000 -30.61 -23.99 -4.64 -0.25 6.90 5.71 5.28 6.69 N/A
Russell 2000 Value -35.66 -29.64 -9.51 -2.42 4.79 4.11 6.83 7.11 N/A

Annual Operating Expenses: 1.20

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. Hench'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.

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 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. 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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