Royce Global Financial Services Fund Manager Commentary
article 06-30-2020

Royce Global Financial Services Fund Manager Commentary

The Fund outpaced both its benchmarks in 2020’s first half, losing less in the down market and outperforming in the upswing period.


Fund Performance

Losing less in down markets and gaining more in upswings is a sure route to relative outperformance—and this was precisely the road Royce Global Financial Services Fund traveled in the first half of 2020. The Fund was down 7.0% for the year-to-date period ended 6/30/20 compared to a loss of 13.0% for its primary benchmark, the Russell 2000 Index, and a decline of 12.8% for its global small-cap benchmark, the MSCI ACWI Small Cap Index, for the same period. The Fund held its value better than each of its benchmarks in the bearish first quarter, when it lost 28.8% versus respective declines of 30.6% and 30.2% for the Russell 2000 and MSCI ACWI Small Cap. When stocks recovered in the second quarter, the Fund rose 30.6% compared to a 25.4% gain for the domestic small-cap index and 24.8% for the global small-cap index.

What Worked… And What Didn't

Three of the portfolio’s four top-detracting positions were banks. Lower interest rates, a global recession, and related concerns about the potential growth of loan defaults were among the factors that hurt performance for the industry in the first half. Popular is the largest bank by both assets and deposits in Puerto Rico, and it ranks as one of the top thrifts by total assets in the U.S. Its stock was specifically hurt by a substantially higher loan loss provision expense in its fiscal first quarter that reflected the newly adopted CECL (Current Expected Credit Losses) accounting pronouncement. BOK Financial is the leading bank based in Oklahoma. Its business suffered from falling oil prices that hurt the energy-dependent economies of Oklahoma and Texas, which drove significant increases in its loan loss provisions. Although its loan business fared relatively better, Capital City Bank Group, which operates in Florida, Georgia, and Alabama, saw its shares fall as its earnings suffered. We held shares in each company at the end of June. On the other hand, we chose to exit our position in Air Lease, which buys and then leases commercial aircraft to airlines around the world. While we like the company’s business model, we were concerned that the airline industry’s likely prolonged road to recovery blunted its prospects.

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The Fund’s top-contributing position was global investment management specialist Sprott. The company consolidated its operations to focus solely on hard assets and found itself well positioned to benefit from the recent appreciation in gold prices and investor expectations that massive central bank interventions will continue to provide a supportive environment for the metal. These same developments boosted the stock of Franco-Nevada, which owns royalties and streams in gold mining and other commodity and natural resource investments. MarketAxess Holdings operates an electronic, multi-dealer trading platform for investment grade and high-yield corporate and emerging market bonds. The company benefited from record quarterly volumes for all of its core products, including U.S. high grade, high yield, emerging markets, and eurobonds. The Tel Aviv Stock Exchange was another top contributor. In late May of 2020, the company reported robust growth in revenue and net profits. The exchange has remained fully operational throughout the pandemic and saw a substantial increase in trading volume as well as higher revenue from listing fees and increases in annual levies.

Top Contributors to Performance Year-to-Date Through 6/30/201 (%)

MarketAxess Holdings1.63
Tel Aviv Stock Exchange1.57
PayPal Holdings1.10

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/202 (%)

Air Lease Cl. A-1.02
BOK Financial-1.01
Capital City Bank Group-0.93
E-L Financial-0.91

2 Net of dividends

Current Positioning and Outlook

We continued to prune the number of positions in the portfolio in the first half of 2020, moving from 68 to 63 holdings, as we focused mostly on the business models in which our conviction is highest. Our industry weights remained largely intact, with the capital markets group remaining by far our largest area of exposure, accounting for more than half of net assets at the end of June. Banks remained our second-largest industry weight, though it followed at a considerable distance. Our largest country weight remained the U.S. at the end of the first half, followed by Canada and the U.K. We think our capital markets holdings together form a diverse group of global businesses, including those involved in traditional, as well as alternative, asset management and securities exchanges. Trading at historically low valuations as of this writing, small-cap bank stocks have been hurt by excess pessimism about the prospects for regional and community banks. We suspect that loan losses may be lower than many investors have been anticipating as higher-risk lending mostly migrated outside of bank lending during the last expansion. Investors may be surprised by how quickly earnings recover as this recession is unique in being caused by a public health crisis as opposed to financial or economic excesses. We believe they will be rewarded by holding businesses with conservatively capitalized balance sheets and strong industry positions. The case is particularly strong in our view for select financial companies whose current valuations do not fully reflect these attributes. Those are the types of stocks we are aiming to hold in the portfolio.

Average Annual Total Returns Through 06/30/20 (%)

Global Financial Services 30.59-6.96-0.633.714.2210.467.197.35 12/31/03

Annual Operating Expenses: Gross 2.07 Net 1.68

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, 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 Gross operating expenses reflect the Fund's gross total annual operating expenses for the Service Class and include management fees, 12b-1 distribution and service fees, other expenses, and acquired fund fees and 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 has contractually agreed, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Service 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 1.49% through April 30, 2021. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies.

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 June 30, 2020, 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 June 30, 2020 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 6/30/20, the percentage of Fund assets was as follows: Sprott was 5.9%, Franco-Nevada was 4.6%, MarketAxess Holdings was 4.4%, Tel Aviv Stock Exchange was 4.0%, PayPal Holdings was 2.3%, Popular was 2.9%, Air Lease Cl. A was 0.0%, BOK Financial was 1.9%, Capital City Bank Group was 1.2%, E-L Financial was 2.9%

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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