Royce Micro-Cap Trust Manager Commentary
article 02-19-2019

Royce Micro-Cap Trust Manager Commentary

In 2018’s difficult market, Royce Micro-Cap Trust stayed ahead of its micro-cap benchmark for the third consecutive year—leaving us confident in the Fund’s cyclical tilt going forward.


Fund Performance

In 2018’s difficult market, Royce Micro-Cap Trust stayed ahead of its micro-cap benchmark for the third consecutive year while slipping only narrowly behind the small-cap index, which it beat in the previous two. The Fund fell 11.6% on an NAV (net asset value) basis and 14.7% on a market price basis in 2018, losing less on an NAV basis than the Russell Microcap Index, which declined 13.1%, while slightly trailing the Russell 2000 Index, which fell 11.0%, for the same period. RMT beat the Russell 2000 on both an NAV and market price basis for the three-, 10-, 20-, 25-year, and since inception (12/14/93) periods ended December 31, 2018. It also outpaced the micro-cap index on both an NAV and market price basis for the three-, 10-, and 15-year periods ended December 31, 2018. (Data for the Russell Microcap Index goes back only to 6/30/00).

What Worked… And What Didn’t

Eight of the Fund’s 11 equity sectors finished 2018 in the red. Industrials detracted most by a wide margin, followed by Energy and Financials. Health Care made a small positive contribution, followed by Utilities and Communication Services. The six industry groups with the largest net losses for the Fund came from five different sectors, which gives a sense of how broad declines were for micro-cap stocks in 2018. By sizable margins, the machinery group was both our heaviest weighting at year-end and the biggest detractor in Industrials, accounting for more than 60% of the sector’s loss in the portfolio. Fourth-quarter difficulties for two machinery stocks—CIRCOR International and Sun Hydraulics (which does business as Helios Technologies)—had negative impacts on performance. CIRCOR makes valves for fluid control systems. Its shares fell in the fourth quarter amid concerns that slowing global growth, U.S.-China trade tensions, and the significant drop in oil prices—energy companies being among its larger end markets—would put a damper on CIRCOR’s positive order trends, pushing out a long-awaited improvement in profit margins and free cash flow earmarked for debt reduction. Sun Hydraulics manufactures hydraulic and electronic controls systems for a variety of industrial and recreational equipment makers. The company continued to book solid incoming orders, but labor and materials cost pressures, as well as a series of operational miscues stemming from a rush to meet growing demand, brought margins and earnings below expectations. We held shares in each company at year-end.

The energy equipment & services industry followed in second place. Slumping oil prices resulted in Energy suffering by far the steepest losses of any sector in the Russell 2000 for the calendar year, while our holdings as a group fared better by comparison. Net losses came from several companies, including Era Group, Computer Modelling Group, SEACOR Marine Holdings, and Carbo Ceramics. We added shares of each of these energy services companies in 2018.

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Mesa Laboratories, the portfolio’s top-contributing (and biggest) position, hails from Information Technology’s electronic equipment, instruments & components group although it does most of its business with hospitals, pharmaceutical and medical device manufacturers, and research laboratories by offering quality control and calibration products and services. Mesa reported record revenues for its fiscal fourth quarter and 2018 in the year's first half, driven in part by strong results in its four divisions and greater efficiencies from the firm’s proprietary operating system that helped it to better manage inventories and speed up deliveries. The firm then reported record fiscal second-quarter revenues in October, geared by strong growth in its sterilization and disinfection control division. Performance-based marketing company QuinStreet has been reaping the benefits of its strategic shift away from for profit education to financial services marketing, with a current focus on the insurance industry. We trimmed our position as its price rose, but see further potential for growth as management begins to apply its marketing algorithms to other areas within financial services.

The Fund’s narrow underperformance versus the Russell 2000 in 2018 was the result of sector allocation—stock selection was additive. Both ineffective stock selection and our overweight hurt in Industrials, while stock picking hindered results in Financials. Conversely, savvy stock selection gave the portfolio an edge in Health Care as well as smaller advantages in Consumer Discretionary and Materials.

Top Contributors to Performance 20181 (%)

Mesa Laboratories0.75
Mirati Therapeutics0.45

1 Includes dividends

Top Detractors from Performance 20182 (%)

CIRCOR International-0.82
Sun Hydraulics-0.49
Collectors Universe-0.37
Major Drilling Group International-0.37
Titan International-0.34

2 Net of dividends

Current Positioning And Outlook

While we acknowledge the many potential sources of risk on the horizon—economic, geopolitical, and financial—we also think that these concerns have already been reflected, perhaps even excessively so, in current valuations. In relatively short order, we transitioned from a period this summer when small- and micro-cap’s extended valuations seemed out of sync given the each asset class’s high levels of debt and low profitability, to one at the end of the year where valuations seemed more pessimistic than we think is warranted—at least in select instances. Down years for small- and micro-cap stocks have often been followed by strong ones. We believe that the portfolio’s cyclical tilt will be rewarded as recessionary concerns dissipate during the year.

Average Annual Total Returns Through 12/31/18 (%)

RMT -25.20-14.65-14.659.302.4712.956.799.319.32 12/14/93
XOTCX (NAV) -19.82-11.62-11.628.253.0113.077.389.3910.08 12/14/93
Russell Microcap -22.14-13.08-13.085.793.0811.715.67N/AN/A N/A

Annual Operating Expenses: N/A

1 Not annualized.

Important Performance, Expense, and Disclosure Information

Important Performance and Expense Information

All performance information reflects past performance, is presented on a total return basis, net of the Fund's investment advisory fee, and reflects the reinvestment of distributions. Past performance is no guarantee of future results Current performance may be higher or lower than performance quoted. Returns as of the recent month-end may be obtained at The market price of the Fund's shares will fluctuate, so that shares may be worth more or less than their original cost when sold.

The Fund normally invests in micro-cap companies, which may involve considerably more risk than investing in larger-cap companies. The Fund's broadly diversified portfolio does not ensure a profit or guarantee against loss.

Closed-End Funds are registered investment companies whose shares of common stock may trade at a discount to their net asset value. Shares of each Fund's common stock are also subject to the market risks of investing in the underlying portoflio securities held by each Fund, respectively. Royce Fund Services, LLC ("RFS") is a member of FINRA and may file this material with FINRA on behalf of each Fund. RFS is not an underwriter or distributor of the closed-end funds.

Current month-end performance may be obtained at our Prices and Performance page.

Notes to Performance and Other Important Information

The thoughts expressed in this report concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at December 31, 2018, and, of course, historical market trends are not necessarily indicative of future market movements. Statements regarding the future prospects for particular securities held in the Funds’ portfolios and Royce’s investment intentions with respect to those securities reflect Royce’s opinions as of December 31, 2018 and are subject to change at any time without notice. There can be no assurance that securities mentioned in this report will be included in any Royce-managed portfolio in the future.

As of 12/31/18, the percentage of Fund assets was as follows: Mesa Laboratories was 3.1%, QuinStreet was 0.9%, Mirati Therapeutics was 0.4%, Surmodics was 1.3%, Etsy was 0.0%, CIRCOR International was 1.0%, Sun Hydraulics was 0.7%, Collectors Universe was 0.4%, Major Drilling Group International was 0.9%, Titan International was 0.3%, BOK Financial was 1.3%, Canadian Western Bank was 0.6%, Village Super Markets was 1.1%

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.

All indexes referred to are unmanaged and capitalization weighted. Each index’s returns include net reinvested dividends and/or interest income. 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. The Russell 2000 Index is an index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 2000 Value and Growth Indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The Russell 1000 Index is an index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 Index. The Russell Microcap Index includes 1,000 of the smallest securities in the Russell 2000 Index, along with the next smallest eligible securities as determined by Russell. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities in the Russell 1000 Index. The Russell Global ex-U.S. Small Cap Index is an index of global small-cap stocks, excluding the United States. The Russell Global ex-U.S. Large Cap Index is an index of global large-cap stocks, excluding the United States. The Russell 2500 is an unmanaged, capitalization-weighted index of the 2,500 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. Returns for the market indexes used in this report were based on information supplied to Royce by Russell Investments. Royce has not independently verified the above described information.

This material contains forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve risks and uncertainties, including, among others, statements as to:

-the Funds’ future operating results,

-the prospects of the Funds’ portfolio companies,

-the impact of investments that the Funds have made or may make, the dependence of the Funds’ future success on the general economy and its impact on the companies and industries in which the Funds invest, and

-the ability of the Funds’ portfolio companies to achieve their objectives.

This discussion uses words such as “anticipates,” “believes,” “expects,” “future,” “intends,” and similar expressions to identify forward-looking statements. Actual results may differ materially from those projected in the forward-looking statements for any reason.

The Royce Funds have based the forward-looking statements included in this commentary on information available to us on the date of the commentary, and we assume no obligation to update any such forward-looking statements. Although The Royce Funds undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events, or otherwise, you are advised to consult any additional disclosures that we may make through future shareholder communications or reports.



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