How did Royce Special Equity Strategy perform in 4Q20?

Royce Special Equity Fund gained 16.4% in the fourth quarter. We were pleased with this result on an absolute basis, though we lagged the Russell 2000 Value Index, which was up 33.4% for the same period. However, the Fund outperformed the small-cap value index for 2020, gaining 7.4% versus 4.6% for the small-cap value index.

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

All nine equity sectors where the Fund held investments made a contribution to performance, with Consumer Discretionary, Industrials, and Information Technology making the most notable impacts. Those are also the portfolio’s largest sectors. The smallest contributions came from Communication Services, Consumer Staples, and Health Care, and these are some of our lowest portfolio weightings. At the industry level, the top contributors for the quarter were semiconductors & semiconductor equipment, which is in Information Technology, and household durables, a group in Consumer Discretionary.

Did any industries have a negative effect on 4Q20’s performance?

We had only two industry detractors in the fourth quarter—IT services (Information Technology) and hotels, restaurants & leisure (Consumer Discretionary).

Which portfolio holdings made the biggest impacts in 4Q20?

Our top-contributing position was Kulicke & Soffa Industries, a company that designs and manufactures capital equipment, related spare parts, and the packaging materials that are used to assemble semiconductor devices.

On the negative side, the biggest detractor was Computer Services, which provides banking, payment processing, and other related services. It had a pretty modest correction in the fourth quarter. Prior to that, it had been a strong performer through most of the year.

What hurt performance relative to the Russell 2000 Value Index in 4Q20?

Most of our underperformance came from ineffective stock selection, though sector allocation also played a role. At the sector level, stock selection hurt relative results in Industrials and Information Technology most. Our substantial cash holdings also hampered relative performance.

Were there any areas that helped performance versus the benchmark?

We benefited from having lower exposure to Real Estate, where our stock selection also helped to a lower degree. An underweight in Health Care and our lack of exposure to Utilities also gave us a relative boost as each of these sectors underperformed within the value index.

Looking at the calendar year, what sectors and industries drove the Fund’s results in 2020?

Six out of nine equity sectors contributed positively to performance. Consumer Discretionary and Information Technology—two of the Fund’s three largest—led by a wide margin. Household durables (Consumer Discretionary) and IT services (Information Technology) contributed most at the industry level while the recreational product manufacturer Johnson Outdoors was our top-contributing position.

Which areas detracted in 2020?

Communication Services detracted the most by far, followed by Real Estate and Materials. Among our industry groups, the top detractors were media (Communication Services), which led by a substantial margin, and specialty retail (Consumer Discretionary). The position that detracted most was media conglomerate Meredith Corporation.

Where were the Fund’s advantages and disadvantages versus the Russell 2000 Value in 2020?

Our outperformance came from sector allocation decisions—stock selection was a negative. At the sector level, our lower exposure to Financials, along with a modest contribution from stock selection, no exposure to Energy, and a combination of our underweight and savvy stock picks in Real Estate all helped versus the benchmark. On the other hand, ineffective stock picking and our overweight in Communication Services hampered relative performance. The positive effect of our higher weight in Materials was undone by poor stock selection while our lower exposure to Health Care overwhelmed the success of our stock picks in the sector.

What is your outlook for 2021?

We’re certainly mindful that over the next several months we could be in for tougher times because of the recent spike in coronavirus cases. However, once more of the population is vaccinated and barring any new, unexpected ‘black swan’ event, we should see economic improvement coinciding with easy earnings comparisons in the second quarter versus 2020’s. In our view, however, this has already been amply priced into most earnings estimates and thus into valuations. In markets that are fully or highly priced, risk-taking that’s driven by low risk-free returns leaves every market vulnerable to shocks. Assets with high valuations that resulted from being discounted at near zero interest rates will therefore not be immune to the laws of gravity. Using the same consistent methodology for picking stocks and determining cash levels in the portfolio, our tried-and-true indicators are predicting lower market returns, as they have accurately done in the past (though admittedly not always in a timely manner). We’re advising caution and raising cash.

Important Disclosure Information