Royce Small/Mid-Cap Premier Fund Manager Commentary
article 02-14-2019

Royce Small/Mid-Cap Premier Fund Manager Commentary

Though we remain cautiously optimistic about the future of the U.S. economy, we believe the portfolio has been positioned well to endure a challenging period.


Fund Performance

Royce Small/Mid-Cap Premier Fund was down 15.2% in 2018, trailing its small- and mid-cap benchmark, the Russell 2500 Index, which declined 10.0% for the same period. Underperformance was the result of the Fund lagging its benchmark through the first three quarters of the year, a bullish period of low volatility in which small-cap growth stocks beat small-cap value, and defensives outpaced cyclicals. We were pleased, then, to see the Fund hold its value better than its index in the fourth-quarter downturn, -14.4% versus -18.5%.

What Worked… And What Didn’t

Certain companies in the consumer, industrial, and industrial commodity spaces were lagging the wider small- and mid-cap markets prior to the fourth-quarter downturn. Within these areas, a number were high-earning cyclical companies that wound up performing better as businesses in 2018 than they did as stocks. In the last months of the year, however, investors were far more concerned with trade and tariff issues, recession worries, and falling energy prices than with the longer-term prospects for these businesses. So while we were pleased to see the Fund hold its value better through the decline, it was an otherwise frustrating year for many of the businesses that we saw as high-quality enterprises in 2018.

While we continue to see many potential sources of risk on the horizon—economic, geopolitical, and financial—we also think that many of these concerns have already been reflected, perhaps even excessively so, in valuations at the end of 2018. In relatively short order, we transitioned from a period this summer when small-cap’s extended valuations seemed out of sync given the index’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.

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Nine of the Fund’s 10 equity sectors detracted from 2018 results, with the most significant negative impacts coming from Consumer Discretionary, Industrials, and Materials. Utilities was the only portfolio sector to make a positive contribution. At the industry level, three groups had a sizable negative effect—capital markets (Financials), chemicals (Materials), and specialty retail (Consumer Discretionary).

Detracting most at the position level was LKQ Corporation, which provides alternative and specialty vehicle parts and operates in North America, Europe, and Taiwan. Positive sales and earnings were not enough to keep its shares from stalling as the firm sought to deal with rising costs, execution issues, trade policy uncertainty, and some additional debt due to its acquisition of Stahlgruber, a European distributor of aftermarket spare parts. The stock of Affiliated Managers Group, which owns a suite of boutique investment firms, also slipped in 2018, mostly due to the market downturn—corrections typically pose problems for the shares of asset management companies. Global staffing and services company ManpowerGroup detracted most in the Industrials sector and third most in the portfolio overall. Its 2018 revenues slid, as the economic environment, particularly in its European business, proved more challenging than the company had been anticipating. Camping World retails recreational vehicles and accessories. Slower-than-expected sales growth in the spring and summer months led many to think that the booming RV market had peaked, a view that was supported when the company had a small earning miss in May. We sold our position in August and September. Air Lease is a leading aircraft leasing business that saw its shares lose altitude throughout the year, particularly in December, when the airline industry came under considerable pressure throughout the eurozone, which resulted in the shuttering of a number of poorly capitalized carriers. Though Air Lease was less exposed to this dynamic, there were concerns among investors that a similar trend would materialize in other geographies. Seeing long-term potential at what we thought was an increasingly attractive price, we added to our position in 2018.

Top Contributors to Performance

1 Includes dividends

Top Detractors from Performance

2 Net of dividends

The portfolio’s top contributor for 2018 was Copart, a leading provider of auctions for salvaged vehicles, which saw increases in volume and revenue per car in 2018. Dorman Products is the leading provider of formerly dealer-only aftermarket auto parts. Demand for auto replacement parts inflected positively as the industry entered the three- to seven-year sweet spot for replacement parts, as well as from replenished auto retailer inventories. In addition, its growth initiatives in heavy duty truck and electronic components continued to take hold.

Relative to the Russell 2500, performance was hurt most in 2018 by stock selection, though sector allocation was also a negative. Ineffective stock picks in Consumer Discretionary made the largest negative impact, with the sector’s distributors and specialty retail industries detracting most. Stock selection and our underweight also hurt relative performance in both the Information Technology and Health Care sectors. Conversely, the portfolio benefited from having no exposure to Energy, which had the worst return in the index for 2018. Stock selection in Industrials was also a source of outperformance, as were the portfolio’s cash holdings.

Average Annual Total Returns Through (%)

Annual Operating Expenses: Label

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 total annual operating expenses for the Service Class as of the Fund's most current prospectus and include management fees, 12b-1 distribution and service 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, 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: Copart was 1.4%, Dorman Products was 2.6%, Core-Mark Holding Company was 0.0%, UGI Corporation was 2.4%, Westinghouse Air Brake Technologies was 0.0%, LKQ Corporation was 2.4%, Affiliated Managers Group was 0.4%, ManpowerGroup was 0.8%, Camping World Holdings Cl. A was 0.0%, Air Lease Cl. A was 2.2%

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.

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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