International Small-Cap Premier Quality Strategy 1Q24 Update & Outlook
article 04-23-2024

International Small-Cap Premier Quality Strategy 1Q24 Update & Outlook

Portfolio Manager Mark Fischer and Assistant Portfolio Manager Mark Rayner update investors on recent performance and their constructive long-term outlook for the Strategy.


How did Royce’s International Small-Cap Premier Quality Strategy perform in 1Q24 and over longer-term periods?

Mark Fischer: The mutual fund that we manage in the Strategy, Royce International Premier Fund, declined -2.3% for the quarter, lagging its benchmark, MSCI ACWI ex USA Small Cap Index, which was up 2.1% for the same period. The portfolio outperformed its benchmark for the 10-year and since inception (12/31/10) periods ended 3/31/24 while trailing for the 1- and 5-year periods.

How was performance at the sector level in 1Q24?

Mark Rayner: Five of the portfolio’s eight sectors made a negative impact on quarterly performance. The sectors making the largest detractions were Health Care, Materials, and Communication Services while Financials, Real Estate, and Consumer Discretionary made positive impacts.

“While we cannot control near-term market perceptions, we believe progress was made in early 2024 to position the Fund for better outcomes over the long term. We added six new holdings at what we think are highly attractive valuations that in our view can help the Fund’s overall return and growth profile going forward.”
—Mark Fischer

What about at the industry level in the first quarter?

MR: The three biggest detractors were health care providers & services, from the Health Care sector, followed by two areas in Industrials: electrical equipment and building products. The biggest contributors were diversified consumer services, which is in Consumer Discretionary, and two other areas from Industrials, professional services and machinery.

Which countries had the biggest effect on first-quarter performance?

MF: Japan, Australia, and Italy detracted most for the quarter, while Sweden, Israel, and South Korea were the largest contributors.

What was the top detractor in the first quarter?

MF: That would be CVS Group, a U.K.-listed company that’s one of the region’s leading providers of veterinary healthcare, with more than 450 vet practices offering high-quality, primary care and, to a lesser degree, more advanced specialist treatments. The company also operates an online retail store, diagnostic laboratories, and crematoria, offering a 'cradle to grave' value proposition to its highly loyal and price inelastic customers. We expect CVS to continue benefiting from an aging cohort of young pets acquired during the pandemic, which will require more expensive care. More important, CVS has long been an industry consolidator. With corporate ownership of the U.K. vet industry having increased from to less than 20% in 2009 to 60% today, CVS has set its sights on the rest of the world, recently expanding into Australia, another sizeable market where corporate ownership is just 15%.

In March 2024, the U.K. Competition Markets Authority (CMA) announced that it was extending an industry-wide review first announced in September 2023 due to the industry’s persistent price hikes through COVID amid the consumer’s cost of living crisis, as well as the view that competition is inadequate in certain regions. Such an extension will likely result in an approximately 18-month period during which the CMA will conduct further diligence to ensure consumers have access to adequate information and competitive alternatives when making decisions about their pets. Uncertainty about the investigation’s outcome has caused CVS’s stock price to fall more than -50% since the CMA’s review got underway. While the range of potential outcomes is wide and unknown, due diligence with industry experts has suggested that industry participants have not engaged in egregious business practices, excess profit taking, or anti-competitive behaviors. It is also thought that remedies will primarily entail greater transparency. This view was reinforced by the former Legal Director and Director of Mergers at the CMA, who noted in a recent interview that mandated price caps or disposals are “very rare.” While we continue to believe that the current share price significantly understates the value of the enterprise, we are maintaining CVS as a relatively smaller position for risk management purposes.

What was the portfolio’s top contributor at the position level for 1Q24?

MR: U.K.-based Marlowe—a business-to-business company that provides a wide range of services and related software products, such as testing and certification of fire safety systems, HR compliance and e-learning software, and audits to ensure compliance with environmental regulations. We like the company’s provisioning of essential and mandated services that are sold into the operating budgets of a highly fragmented customer base of more than 40,000 companies. This in turn creates longstanding customer relationships, which average 12 years, and recurring or predictable revenues amounting to approximately 85% of the group total. Marlowe is also a leading consolidator of its large and fragmented addressable markets: It typically redeploys its ample cash flows into attractively priced, bolt-on acquisitions which in turn leads to logical cross-selling opportunities and scale advantages.

Marlowe announced that it would undergo a strategic review late last year. Its shares rallied in February on the results of this review. Marlowe reported that a private equity buyer has agreed to acquire Marlowe’s Governance, Risk & Compliance (“GRC”) segment, which accounts for approximately 40% of Group earnings before interest, taxes, depreciation, and amortization (“EBITDA”), for approximately £430 million, the equivalent of more than 16x the GRC segment’s EBITDA and more than 120% of Marlowe’s overall market capitalization. It is anticipated that Marlowe will use the proceeds to pay off all of its debt as well as return a special dividend of up to £200 million to shareholders. We believe that, while this transaction has crystallized substantial near-term value for shareholders, the implied valuation of the remaining Testing, Inspection and Certification (TIC) business still provides significant future upside. We remain attracted to the key business attributes of the TIC business; Marlowe’s now debt-free position will enable it to continue consolidating its end markets.

At the sector level, how did the Fund perform versus the MACI ACWI ex USA Small Cap in the first quarter?

MR: The Fund’s disadvantage versus its benchmark was attributable to stock selection in the quarter, as our sector allocation decisions were additive. At the sector level, stock selection detracted most in Industrials (where our larger weighting was a positive), Health Care (where our higher exposure also hurt), and Information Technology. Conversely, our much lower exposure and, to a lesser extent, stock selection were relative strengths in Real Estate, as were our lack of exposure to Consumer Staples and Utilities.

What is your outlook for the Strategy?

MF: Despite the Fund’s outperformance in late 2023—and initially encouraging signs that the trend could last—the portfolio’s holdings were unable to build on this momentum in 1Q24. The results were broad based, as nearly 70% of our companies lagged the benchmark during the period, consistent with the relative performance headwinds experienced over the Fund’s more than 10-year history during periods when bond yields were rising. We do not believe that current market valuations reflect the underlying quality and growth potential for most of our holdings. The private markets, however, provided another reminder of our view of underlying value during the quarter, as one of our U.K.-listed companies announced that a private equity buyer had agreed to acquire a business segment that accounts for approximately 40% of overall EBITDA for the equivalent of more than 120% of the company’s overall market capitalization. Notably, this was the fifth instance that a portfolio company received a take-over bid over the last 12 months. So, while we cannot control near-term market perceptions, we believe progress was made in early 2024 to position the Fund for better outcomes over the long term. We added six new holdings at what we think are highly attractive valuations that in our view can help the Fund’s overall return and growth profile going forward.

Important Disclosure Information

Average Annual Total Returns as of 3/31/2024 (%)

NET               GROSS
International Premier -2.27 -1.94 -6.01 2.09 4.85 5.25 12/31/10  1.44  1.59
2.11 12.80 0.38 6.24 4.74 4.97 N/A  N/A  N/A
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 Gross operating expenses reflect the Fund's total gross annual operating expenses for the Investment Class and include management 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 & Associates has contractually agreed, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Investment 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 1.19% through April 30, 2024.

All performance and risk information presented in this material prior to the commencement date of Investment Class shares on 1/22/14 reflects Service Class results. Service Class shares bear an annual distribution expense that is not borne by Investment Class shares.

Mr. Fischer’s and 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 3/31/24 (%)

  International Premier

CVS 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.

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.

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.

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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