Premier Quality Strategy—1Q21 Update and Outlook—Royce
article 04-14-2021

Premier Quality Strategy—1Q21 Update and Outlook

Lead Portfolio Manager Chuck Royce and Portfolio Managers Lauren Romeo, CFA and Steven McBoyle provide an update on how our Small-Cap Premier Quality Strategy performed as well their optimistic outlook for the rest of the year.

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How did the Small-Cap Premier Quality Strategy perform in 1Q21?

Chuck Royce Royce Premier Fund, the mutual fund that we manage in this Strategy, advanced 10.5% for 1Q21. This was a strong quarterly result on an absolute basis, though it lagged its benchmark, the Russell 2000 Index, for the same period. However, we were pleased that the Fund still led its benchmark on the trailing five-, 15-, 20-year, and since inception (12/31/91) periods through the end of March 2021.

Steven McBoyle Quarterly results were admittedly somewhat frustrating because small-cap stocks with earnings, dividends, and higher profitability led after lagging in the fourth quarter—and those are fundamentals that we emphasize in our own holdings. However, we remain very confident about the long-term prospects for our companies, especially against the backdrop of a recovering global economy.

Which areas of the portfolio made the biggest positive impact on performance?

Lauren Romeo All eight of the equity sectors where we held investments made contributions to performance in the first quarter. Industrials and Information Technology—the portfolio’s two largest sectors—as well as Materials, made the biggest positive impacts. 

Which industries and companies did well in 1Q21?

LR At the industry level, we saw strong contributions from machinery, which is in Industrials, and electronic equipment, instruments & components, which is part of Information Technology. These are regular areas of interest for us and were the Fund’s two largest industry weightings at the end of March.

SM The portfolio’s top-contributing position for the quarter was Coherent, a leading manufacturer of laser-based photonic products. Multiple companies engaged in a takeover battle for the company at progressively higher offering prices. Valmont was another notable contributor. They provide various structures for utility companies, coating services for infrastructure, and irrigation equipment for farmers.

CR Both are companies that we’ve owned for the last several years. They each fit one of our more prominent quality themes: fundamentally strong companies that help other businesses innovate or automate, which are skills that have seen considerable acceleration through the pandemic and in our view will be sustainable as the economy expands.

What areas hurt 1Q21 performance?

LR All of our sectors were positive in the quarter, but the portfolio received pretty modest contributions from Health Care, Consumer Staples, and Financials. Health care equipment & supplies and commercial services & supplies, which is in the Industrials sector, were the largest industry detractors.

CR Electronic measurement instrument maker Mesa Laboratories was the position that detracted most. We still like its long-term prospects. Ritchie Brothers Auctioneers also hindered results. It auctions off used industrial equipment, and its business model is usually pretty counter cyclical because more unused inventory tends to be put up for auction in economic slowdowns. With most investors understandably anticipating economic acceleration, there are concerns that the company’s growth opportunities may be modest through the near term.

How did the Fund perform versus the Russell 2000 in the first quarter?

SM Our underperformance relative to the Russell 2000 came mostly from lackluster stock selection. Our sector allocation decisions made a positive impact. Several of our holdings in the capital markets industry declined in the quarter, which gave Financials the greatest negative effect versus the benchmark. Consumer Discretionary also hampered relative results due to both our underweight and lagging stock selection in what was a strongly performing sector within the Russell 2000.

LR The Fund also had no holdings in two of Consumer Discretionary’s strongest rebounding industries—specialty retailing and hotels, restaurants & leisure—as we rarely find the kind of high-quality, asset light, durable business models that we like in these industries. However, we did benefit on a relative basis from the portfolio’s underweight in the Health Care sector, which lagged within small cap. Savvy stock selection helped in Information Technology, though our larger exposure to the sector, which also trailed within the index, mitigated that relative advantage. 

What is your outlook for this Strategy?

CR Our long-term view is optimistic. We base this on the underlying qualities of our holdings as well as the history of small-cap bull cycles. If subsequent returns follow the pattern of the past two decades, the current market may be starting to shift in two important ways for the Fund’s investors. First, while we think small caps as a whole will deliver positive returns over the next several years, these returns are likely to be lower than the high rates that small caps have compounded at over the past three- and five-year annualized periods—which were, respectively, 14.8% and 16.4%. Second, the second year of a market advance has historically seen stocks with higher ROEs begin to lead. And we feel confident that lower overall market returns with high-quality leadership should support attractive relative results for Premier Fund.

“Our long-term view is optimistic. We base this on the underlying qualities of our holdings as well as the history of small-cap bull cycles.” — Chuck Royce

LR Based on what Chuck said, we’ve made some adjustments to better position the portfolio for the market environment we see unfolding. We’ve continued to invest in companies that help their customers raise their productivity. For example, we added a holding that provides a series of platforms which allow financial advisors, institutional investors, and asset managers to improve their productivity. We also increased our investment in a specialist technology provider to community banks.

SM In addition, we added to our holdings in two leading Consumer Discretionary companies based on the indicators we see of increased spending on both premium brands and certain leisure activities. We also sold down one of our holdings that received a takeover offer and trimmed a few positions in Information Technology whose valuations were running high positions in favor of the holdings Lauren and I described, which have lower valuations.

 

ROYCE PREMIER FUND

 

Important Disclosure Information

Average Annual Total Returns as of 3/31/21 (%) 

  1Q211 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Premier 10.45 70.56 13.53 16.63 9.94 9.92 11.59 12.03 12/31/91
Russell 2000 12.70 94.85 14.76 16.35 11.68 8.83 9.76 10.27 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, Ms. Romeo’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 3/31/2021 (%)

  Royce 
Premier Fund

Coherent

0.0

Valmont

2.6

Mesa Laboratories

1.7

Ritchie Brothers Auctioneers

1.1

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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