Royce Pennsylvania Mutual Fund Manager Commentary
article 12-31-2019

Royce Pennsylvania Mutual Fund Manager Commentary

Our flagship portfolio not only beat its benchmark in 2019, but it also held its long-term relative advantage for the three-, five-, 15-, 20-, 25-, 30-, 35-, and 40-year periods ended 12/31/19.


Fund Performance

2019 marked the fourth consecutive year in which our flagship, Royce Pennsylvania Mutual Fund, beat its small-cap benchmark, the Russell 2000 Index, helping the portfolio to outperform the small-cap index for the three-, five-, 15-, 20-, 25-, 30-, 35-, and 40-year periods ended 12/31/19. The Fund advanced 26.6% in 2019 versus a gain of 25.5% for the Russell 2000. Following the Fund’s strong showing in 2018’s more challenging environment, we were equally pleased to see it also do well in 2019’s more bullish, and far less volatile, market.

What Worked… And What Didn’t

Nine of the portfolio’s 11 equity sectors finished 2019 in the black. Our two largest sector weightings—Industrials and Information Technology—made by far the biggest contributions to calendar-year performance while Communication Services and Utilities were the only sectors that detracted. Semiconductors & semiconductor equipment (Information Technology), machinery (Industrials), and electronic equipment, instruments & components (Information Technology) contributed most on an industry basis. The impact of detracting industries was, unsurprisingly, far more modest, led by internet & direct marketing (Consumer Discretionary), media (Communications Services), and oil, gas & consumable fuels (Energy).

Ares Management was the top-contributing position in 2019. The firm is an asset manager that focuses on tradable credit, direct lending, private equity, and real estate. Investors became more optimistic about the company’s ability to sustain mid-teens, high margin earnings growth for an extended period. The company also converted to C-corp. status, which broadened ownership, supporting an increase in its valuation. The two stocks that followed were also the leading contributors from the Information Technology sector—Cirrus Logic, a leading producer of specialized audio and voice devices and solutions, and MKS Instruments, which manufactures devices and instruments used in semiconductor production. After several strong months, shares of Cirrus rose by double digits in October on news of better-than-expected third-quarter results keyed by increased demand for its innovative products. MKS Instruments also sailed past (admittedly fairly low) third-quarter earnings estimates. It pleased us to see revenues in its advanced markets segment rise as well as what looked like a bottom in the semiconductor capital equipment cycle.

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Virtu Financial detracted most at the position level. Virtu is a New York City based financial company that uses its technology to act as a market maker and liquidity provider to the global financial markets. Its business endured a slump through most of the year, and the company typically does best in highly volatile markets—which were mostly absent in 2019—and/or when global trading volumes are heavy. Believing that volatility is more likely, we built our position. Merit Medical Systems manufactures devices for diagnostic and interventional cardiology and radiology procedures. We chose to move on from the stock after the company reported two consecutive quarters of disappointing earnings. Diversified publishing and broadcasting company Meredith Corporation was hurt by declining revenues and earnings as the company tries to navigate an ever-shifting media landscape.

The Fund’s outperformance versus the Russell 2000 was the result of both positive sector allocation and savvy stock selection. Information Technology was the greatest source of outperformance due to both our overweight and superior stock selection, with semiconductors & semiconductor equipment standing out. The Fund also saw outperformance from Industrials from the same combination of larger exposure and better stock selection.

The two largest areas of relative underperformance were Health Care, where the Fund’s underweight in biotechnology and ineffective stock selection were the primary culprits, and Materials, where underperformance was largely due to lagging stock selection. Quaker Chemical, a provider of custom-formulated specialty products for use primarily in the steel and automotive industries, and Stella-Jones, which produces pressure-treated wood for utility poles and railroad ties, were the largest detractors in the sector.

Top Contributors to Performance 20191 (%)

Ares Management Cl. A0.88
Cirrus Logic0.87
MKS Instruments0.68
HEICO Corporation0.68
Genworth MI Canada Inc.0.57

1 Includes dividends

Top Detractors from Performance 20192 (%)

Virtu Financial Cl. A-0.35
Merit Medical Systems-0.26
Meredith Corporation-0.21
FutureFuel Corporation-0.17
Pason Systems Inc.-0.14

2 Net of dividends

Current Positioning And Outlook

The backdrop looks quite favorable to us for solid to strong small-cap performance overall. We have previously cited four favorable factors in the current market environment—low inflation, modest valuations, moderate growth, and ample access to capital. Each of these remains present and suggests that small-cap returns can go higher. We see a global economy that’s showing signs of renewed life, an ISM Manufacturing Index that’s been incrementally rising (despite December’s setback), and, most important, valuations that range from reasonable to attractive among the many small-cap cyclical areas that we typically like best. While 2019 was a very strong year for small-cap stocks, two consecutive years of double-digit increases are fairly common for this asset class. Periods in which a healthy second year followed a strong one came in 1988-9, 1991-2, 1995-6, 2003-4, 2009-10, 2012-13, and 2016-17. With the favorable conditions we’ve outlined above in mind, we suspect that the current small-cap rally can continue, with the potential to add 2019-20 to this list.

Average Annual Total Returns Through 12/31/19 (%)

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR 30YR 45YR
Pennsylvania Mutual 8.7426.5626.56 9.95 8.28 10.52 8.08 10.12 10.32 15.37
Russell 2000 9.9425.5225.52 8.59 8.23 11.83 7.92 7.59 9.49 N/A

Annual Operating Expenses: 0.94

1 Not annualized.

Important Performance and Disclosure Information

Important Performance and Expense Information

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.

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, 2019, 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, 2019 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 12/31/19, the percentage of Fund assets was as follows: Ares Management Cl. A was 1.0%, Cirrus Logic was 0.8%, MKS Instruments was 0.8%, HEICO Corporation was 0.8%, Genworth MI Canada was 1.2%, Virtu Financial Cl. A was 0.8%, Merit Medical Systems was 0.0%, Meredith Corporation was 0.3%, FutureFuel Corporation was 0.0%, Pason Systems was 0.6%

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 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 2500 is an unmanaged, capitalization-weighted index of the 2,500 smallest publicly traded U.S. companies in the Russell 3000 index. The returns for the Russell 2500-Financial Sector represent those of the financial services companies within the Russell 2500 index. 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 Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks.The MSCI ACWI ex USA Small Cap Index is an index of global small-cap stocks, excluding the United States.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.

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. (Please see ""Primary Risks for Fund Investors"" in the prospectus.)



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