PENNX—2Q21 Strategy Update and Outlook—Royce
article 07-20-2021

Penn—2Q21 Strategy Update and Outlook

The portfolio management team for our flagship, Royce Pennsylvania Mutual Fund, is led by Chuck Royce, along with Portfolio Managers Jay Kaplan, Lauren Romeo, Steven McBoyle, Andrew Palen, and Miles Lewis. We asked Chuck, Steven, and Andrew to update clients on the portfolio’s recent performance and explain their optimistic outlook.


How did Royce Pennsylvania Mutual Fund perform in 2Q21?

Chuck Royce The Fund advanced 2.8% in 2Q21 and trailed its benchmark, the Russell 2000 Index, which was up 4.3% for the same period. For the year-to-date period ended in June, Penn rose 16.6% versus a 17.5% gain for the benchmark, which is a terrific absolute return for any six-month period, even though we lagged the index a bit for that period. We’ve noted to our investors previously that, due to Penn’s high weighting in higher-quality companies, we have often lagged when small caps surge ahead in a relatively compressed time period. In spite of some recent relative performance challenges, we were also pleased that the Fund maintained its longer-term advantage. Penn beat its benchmark for the 20-, 25-, 30-, 35-, and 40-year periods ended 6/30/21.

Can you give us some details on the Fund’s sector results in 2Q21?

Steven McBoyle We were invested in 10 equity sectors during the second quarter, and each one finished the quarter in the black. The largest positive contributions came from Information Technology, Health Care, and Financials while the smallest came from Consumer Staples, Communication Services, and Real Estate—three of the portfolio’s four lowest sector weightings.

What happened at the industry level during the second quarter?

Andrew Palen Our three top contributors were a diverse group: semiconductors & semiconductor equipment from Information Technology, hotels, restaurants & leisure in Consumer Discretionary, and capital markets, which is in Financials. The industries that detracted most, on the other hand, all came from the Industrials sector, which lagged the Russell 2000 overall: road & rail, construction & engineering, and building products. We should note that we’re constructive on the long-term prospects for each of these three groups and remain bullish on the sector as a whole.

What position contributed most for the second quarter?

AP The top contributor in the second quarter was Scientific Games. The company develops, manufactures, and distributes a host gaming, lottery, sports betting, and other information-based products and services. It’s seen improvement for its newer product launches and beat earnings expectations for its fiscal first quarter of 2021. We also like that it’s paid down debt and has products and services that we think could potentially be profitably spun off.

Which holding detracted most for 2Q21?

SM The position that created the biggest drag on performance was Upland Software, which is a company that provides cloud-based enterprise work management software. Back in May, Upland reported results that exceeded expectations, showing increased growth and strong free cash flow. The company also completed two accretive acquisitions recently—Second Street and BlueVenn. We remain attracted to Upland’s mission critical B2B software tools, its strong customer relationships (98% net retention), and the way it consistently executes M&A. Despite these positive developments, the stock began to fall during May—but this peculiar dynamic is fairly consistent with previous reactions around the company’s earnings. For our part, we were pleased with the results and continue to think highly of its long-term prospects.

How did the Fund stack up relative to the Russell 2000 in 2Q21?

CR Our disadvantage came from both stock selection and sector allocation. The former had a bigger impact. Our lower exposure and ineffective stock picking hurt our relative results in Communication Services. I should probably add that this sector was dominated by meme stocks in the quarter. Our larger weighting in Industrials and a combination of poor stock picks and lower exposure to the resurgent Energy sector also detracted. On the other hand, savvy stock selection and our lower weighting were both additive in Health Care, which trailed the index as a whole. We also made effective stock picks and had lower exposure in Financials, as well as a lack of exposure to Utilities—each sector was an additional source of outperformance, especially because both lagged the Russell 2000 in 2Q21.

Can you talk about which sectors had the greatest impact on the portfolio for the year-to-date period ended 6/30/21?

SM Each of the 10 equity sectors where we had investments made positive contributions to performance. The largest came from Industrials, Information Technology, and Consumer Discretionary, while the smallest were in Communication Services, Consumer Staples, and Energy. These last three were the portfolio’s lowest sector weightings for the six-month period.

What was notable about year-to-date performance at the industry level?

AP At the industry level, our top contributors were semiconductors & semiconductor equipment, banks—which are in Financials and were very strong in 1Q21—and electronic equipment, instruments & components, another group in Information Technology. We were pleased that only three industries finished the year-to-date period in the red: health care technology from Health Care, metals & mining in the Materials sector, and consumer finance from Financials.

What position contributed most in the first half of 2021?

SM Our top contributor for the first half was Kulicke & Soffa Industries, which designs and manufactures capital equipment, related spare parts, and packaging materials used in semiconductor device assembly. The company reported strong results for its fiscal second quarter in May, citing increased global reliance on semiconductors and the growing capital intensity within the assembly process as the primary drivers behind its recent success.

Which holding detracted most for the same first-half period?

AP The top detractor at the position level was GCM Grosvenor, an investment management company focused on private equity, infrastructure investments, real estate, credit finance, and absolute return. Its shares fell after the company reported fiscal first-quarter results in mid-May that showed better-than-expected revenues but earnings that seemed to fall short of other investors’ expectations. We added shares through most of the first half.

What sectors did the most to help or hurt the Fund’s year-to-date results vis-à-vis the Russell 2000 Index?

SM Relative to the Russell 2000 for the year-to-date period, our underperformance came entirely from stock selection—our sector allocation decisions had a modestly positive effect. What hurt our relative results most at the sector level was a combination of lower exposure and ineffective stock selection in both Energy and Communication Services. In Materials, we had a positive effect from our higher weighting that fell short of the impact from stock selection miscues in the period. Conversely, our lower weighting in the lagging Health Care sector, along with a small assist from stock selection, was additive vis-à-vis the benchmark—just as in 2Q21. Successful stock picks in Information Technology, which outweighed the negative impact of our larger weighting, and having no exposure to lagging Utilities also helped relative results.

What’s your outlook for the Fund?

CR A few cyclical sectors began to lag the Russell 2000 in mid-May when the yield curve flattened with the decline in the 10-year Treasury yield. These short-term shifts have not altered our constructive stance on the Fund’s economically sensitive holdings, however. We’re still confident that cyclical small caps are poised for a strong run in the coming years. Our confidence is underscored by current expectations for strong nominal GDP growth in the U.S. this year and next coupled with an accommodative Fed and attractive relative valuations. Equally important, we remain excited about the opportunities in small caps, an asset class with a large number of diverse and interesting companies and evolving industries. We’ve recently been focusing even more than usual on identifying businesses that were able to use the difficulties created by the pandemic and ensuing recession to get stronger. We’ve been finding these kinds of businesses selling at what we think are attractive valuations largely in Industrials, Information Technology, and Financials. We believe that we’re embarking on the leg of the cycle when company results, rather than valuation expansion, typically begin to drive most of the stock price movement—and we think that’s an environment that suits our skill sets well.




Important Disclosure Information

Average Annual Total Returns as of 6/30/21 (%) 

  2Q211 1YR 3YR 5YR 10YR 15YR 20YR 30YR 45YR
Pennsylvania Mutal Fund 2.75 53.88 12.89 15.75 10.55 8.86 9.87 11.10 13.31
Russell 2000 4.29 62.03 13.52 16.47 12.34 9.51 9.26 10.65 N/A

Annual Operating Expenses: 0.95

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 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, McBoyle’s, and Palen’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 6/30/2021 (%)

Mutual Fund

Scientific Games


Upland Software


Kulicke& Soffa Industries


GCM Grosvenor


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. The Fund invests primarily in small and micro-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss. The Fund may invest up to 25% of its net assets in foreign securities that 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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