RYIPX 3Q20 Update & Outlook—Royce
article 10-26-2020

International Premier Quality Strategy—3Q20 Update and Outlook

Portfolio Manager Mark Rayner offers an update on how our International Small-Cap Premier Quality Strategy performed in 3Q20 and discusses his outlook.


How did the International Small-Cap Premier Quality Strategy perform in 3Q20?

Royce International Premier, the mutual fund that we manage in our International Small-Cap Premier Quality Strategy, rose 10.3% in 3Q20. It narrowly trailed its benchmark, the MSCI ACWI ex-USA Small Cap Index, which was up 10.5% for the same period. However, the portfolio handily outpaced its benchmark for the year-to-date period, up 2.1% versus a decline of 3.6%, while also beating it for the one-, three-, five-year, and since inception (12/31/10) periods ended 9/30/20.

Which areas of the portfolio made the biggest impacts on performance?

Eight of the nine equity sectors in which we held investments made positive contributions to performance. Industrials, which is our largest sector weight, led by a wide margin and was followed by notable positive impacts from Information Technology and Materials.

What hurt 3Q20 performance?

Energy was the only sector that detracted from third-quarter results while Communication Services and Consumer Discretionary made the smallest contributions. These three sectors were also among our lowest weightings at the end of September. It’s notable that at the sector and industry level, we saw cyclical areas such as machinery (Industrials) and chemicals (Materials) do well as part of a widespread rebound for cyclical stocks to which Energy remained an exception. The sector’s energy equipment & services group was the only industry in the portfolio that detracted from quarterly performance.

Can you discuss a portfolio holding that did well in 3Q20?

Our top contributor at the position level was IMCD, a Dutch company that provides specialty chemicals and food ingredients. IMCD reported strong results for the first six months of 2020 in mid-August, with improved gross profits and earnings. Like most businesses, the company is facing challenges created by COVID-19, but its earnings for the fiscal second quarter were similarly positive thanks to strength in its American and Asia Pacific markets.

What about a company that hurt third-quarter performance?

The most notable was Australia’s Bravura Solutions Limited, which provides software solutions for the wealth management and funds administration industries. It was the top detracting position in 3Q20. In late August, the firm reported positive results for the fiscal year ended 6/30/20, a period that saw revenues climb by 6% and EBITDA jump by some 19%. However, the company also reported a lengthening of the sales cycle, no new customer deals, and a generally conservative outlook for 2021—all primarily related to the ongoing impacts of COVID-19. This news appeared to fall short of investors’ expectations as the shares corrected on the report, despite the progress made so far in 2020. I should also mention that our long-term experience with Bravura has been positive. It was among the Strategy’s top-10 contributors, for example, over the three-year period ended 9/30/20 and remained one of our largest positions at the end of September.

What hampered 3Q20 performance relative to the MSCI ACWI ex-USA Small Cap?

Our modest disadvantage came largely from underperformance in two sectors in addition to the negative impact of the portfolio’s cash holdings. Ineffective stock selection hindered results in Health Care, mostly due to a disappointing performance from Brazil’s OdontoPrev, which primarily provides dental insurance services, including the management, sale, and provision of private dental care plans and services. At the end of July, the company actually reported an 87% increase in net profits for the second fiscal quarter. However, the market correctly saw this as a temporary, COVID-19-induced tailwind. With access to dentists substantially reduced due to regional lockdowns in Brazil, OdontoPrev’s ‘dental loss ratio’ or dental reimbursement costs, fell from 45% of revenues a year earlier to just 33%. This loss ratio will correct in subsequent quarters and indeed swing the other way as lockdowns are lifted. This effect may be accentuated over the short- to medium-term if the economic downturn in Brazil continues to subdue membership growth for OdontoPrev’s dental plans, thereby obscuring the otherwise compelling long-term growth potential in Brazi’s dental market.

Were there areas that helped relative performance in the third quarter?

Yes, three sectors were strong compared to the benchmark. Our significantly lower exposure was additive in Real Estate while stock selection drove relative success in Information Technology and Industrials, our two largest sector weights. In Real Estate, we also enjoyed relative and absolute success with Altus Group, a Canadian company that provides real estate consulting and advisory services, which was particularly strong. Its stock price surged after the company reported earnings in August that exceeded expectations, showing a business model with impressive resilience despite COVID-related economic shutdowns. Altus’s property tax consulting revenue was also notably strong, with solid growth and expanding margins. All of this suggested to us that its profit outlook is stronger than was previously appreciated by investors. The company’s cloud-based services are also adapting well to the work-from-home transition among its clients.

Let’s turn to the year-to-date period ended 9/30/20. How did the Strategy perform for that period?

Six of the Fund’s nine equity sectors made a positive impact on performance, with the largest contribution by far coming from Information Technology, which was followed by Health Care. And each of the three sectors that detracted—Energy, Communication Services, and Industrials—made comparatively very modest impacts.

Which holding performed best?

Japan’s Daifuku, which makes material handling equipment such as automated storage systems, conveyors, and automatic sorters, was our top contributor for the year-to-date period. We like its leading global positions in a diverse selection of attractive end markets that range from automated warehousing to semiconductor manufacturing, as well as its large and increasing share of aftermarket revenues. This supports enduring customer relationships that can generate 15-20 years of repeat revenues. In August, Daifuku reported favorable results for its 2020 fiscal first quarter, including a 40%-plus increase in operating income over 2019’s first fiscal quarter. The company also announced that it was maintaining its cautiously optimistic outlook for 2021.

Which position hurt year-to-date performance most?

Norway’s TGS-NOPEC Geophysical, which is our lone position in the Energy sector, saw its shares decline. The company provides geoscience data to oil and gas exploration and production companies worldwide. The ongoing struggles in the energy industry have had a markedly negative impact on the exploration budgets of TGS-NOPEC’s customers. Given the cyclical nature of its business, we have always sought to manage our position in an effort to take advantage of this cyclicality, especially in light of the company’s ability to rapidly flex up and down its operating and capital expenditures to continue generating cash in even the most severe downturns. To that point, we were pleased that TGS-NOPEC has been effectively managing its business through an extraordinarily difficult period. For example, the company generated improved cash flow from operations in 2Q20 compared to 2Q19. Its balance sheet also remains strong, positioning TGS to continue generating strong cash flow and industry-leading returns on capital.

Where did the Fund have an advantage versus its benchmark?

We had a substantial relative advantage in the year-to-date period from both stock selection and sector allocation decisions, with the latter having a slightly more additive effect. The portfolio’s biggest edge on a sector basis came from savvy stock selection in Industrials, which also easily outweighed the negative effect of our greater exposure. In addition, the portfolio benefited from its lower weighting and, to a lesser degree, effective stock selection in Real Estate, as well as a substantial stock selection advantage—and the more modest positive effect of lower exposure—in Financials.

Which areas hurt relative year-to-date results?

Stock picking hurt our year-to-date relative results most in Communication Services due to poor performance from the U.K.’s Hyve Group, an event organizing company that we exited back in March. Health Care also hindered relative results. Although our higher weighting was additive in Health Care, our position in OdontoPrev had a greater negative impact for the year-to-period.

What is your outlook for the International Premier Quality Strategy?

“As always, we tried to steer a middle course, letting neither undue optimism nor pessimism drive our investment decisions, preferring to remain highly process driven both in our approach to managing the Strategy and in finding new ideas.” — Mark Rayner

We’ve seen a strong recovery in non-U.S. small-caps, which began in April and continued in 3Q20, though it did so amidst the considerable economic uncertainties caused by the pandemic. As always, we tried to steer a middle course, letting neither undue optimism nor pessimism drive our investment decisions, preferring to remain highly process driven both in our approach to managing the Strategy and in finding new ideas. Although we added no new names in the third quarter, we did add a number to our large database of investable companies, including several based in Japan, where we continued to uncover high-quality business models with strong balance sheets, often at what we deem to be attractive valuations. In our meetings with Japanese management teams over the years, a picture has often been painted of the need for the country’s SMEs to invest more in digital technology to overcome a certain ‘IT illiteracy.’ Japanese software and IT services companies have therefore been a fruitful area of investment for us. So we were pleased to note that a key area of focus of Japan’s new Prime Minister, Yoshihide Suga, is the rapid digital transformation of the country’s public and private sectors through the creation of a new government position of Minister for Digital Transformation.




Important Disclosure Information

Average Annual Total Returns as of 9/30/20 (%) 

International Premier 10.31 17.79 8.27 12.42 8.14 12/31/10
MSCI ACWI x USA SC 10.50 6.97 0.93 6.80 4.27 N/A

Annual Operating Expenses: Gross 1.58 Net 1.44

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 2% 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. Gross operating expenses reflect the Fund's total gross annual operating expenses for the Service Class and include management fees, 12b-1 distribution and service fees, and other expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund's most current prospectus. Royce has contractually agreed, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Service Class's net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below 1.44% through April 30, 2021.

Mr. Rayner’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 9/30/2020 (%)

  Royce International 
Premier Fund



Bravura Solutions Limited


OdontoPrev SA


Altus Group Ltd.


Daifuku Co., Ltd.


TGS-NOPEC Geophysical Company


Hyve Group


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.

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 unmanaged, capitalization-weighted 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.

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 may invest a significant portion of its assets in foreign companies which may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic, or other developments that are unique to a particular country or region. These risk factors may affect the prices of foreign securities issued by companies headquartered in developing countries more than those headquartered in developed countries. (Please see "Investing in Foreign Securities" in the prospectus.) Therefore, the prices of the securities of foreign companies in particular countries or regions may, at times, move in a different direction than those of the securities of U.S. companies. (Please see “Primary Risks for Fund Investors” in the prospectus.) The Fund invests primarily in small-cap stocks, which may involve considerably more risk than investing in 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.)



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