Royce Total Return Fund Manager Commentary
article 06-30-2020

Royce Total Return Fund Manager Commentary

The Fund finished 2020’s first half between its two benchmarks and showed similar relative performance pattern held for longer-term periods.


Fund Performance

For the year-to-date period ended 6/30/20, the Fund fell 17.3%, sandwiched between its two small-cap benchmarks: the Russell 2000 Index declined 13.0% while the Russell 2000 Value Index lost 23.5% for the same period. A similar relative performance pattern held for longer-term periods: the Fund led the Russell 2000 Value for the one-, three-, five-, 10-, 15-, 20-, 25-year, and since inception (12/15/93) periods ended 6/30/20, while it trailed the Russell 2000 for all but the 20-, 25-year, and since inception periods.

What Worked… And What Didn't

Only three of the 12 equity sectors in which the Fund held investments finished 2020’s first half in the black. Financials and Industrials made the biggest negative impacts, followed by the Energy sector, where we had a much lower weighting. Decidedly modest positive contributions came from Health Care, Materials, and Communication Services. Banks and insurance, each in Financials, were the largest industry detractors. Perhaps surprising to some, another industry in the same sector—capital markets—was the leading industry contributor, demonstrating our longstanding view that the Financial sector contains greater diversity than is often appreciated. Building products (Industrials) followed in second place among positive contributors while automobiles (Consumer Discretionary) was the third largest.

CIT Group, a financial holding company that operates CIT Bank, detracted most at the position level in the first half of 2020. Challenging economic conditions resulting from the coronavirus hurt its fiscal first-quarter results, which also included goodwill impairment charges, primarily related to an acquisition. Optimistic about its long-term prospects, we held our stake at the end of June. On the positive side, Canada’s Sprott, a global asset manager that specializes in precious metals strategies, was the top contributor, primarily due to investor expectations that massive central bank interventions will maintain a supportive environment for gold prices.

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Relative to the Russell 2000, the Fund suffered as the negative impact from sector allocation overwhelmed our relatively more successful stock selection efforts. Health Care was the largest detractor, which was entirely due to our underweight in the only sector to post a positive return in the first half. The success of Health Care was largely due to strong performance from biotechnology, where the Fund rarely has holdings as dividend payers are scarce in that space. Our underweight in Information Technology, another sector with relatively few dividend payers, also helped drive underperformance, though the Fund’s holdings also lagged those in the index. Conversely, Materials was a source of relative strength due to savvy stock selection, notable in both the chemicals and the metals & mining industries. Real Estate also contributed to relative results due to our lower exposure to this lagging sector.

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

Ares Management Cl. A0.43
Gold Fields ADR0.39
TMX Group0.34
Virtu Financial Cl. A0.30

1 Includes dividends

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

CIT Group-0.66
Assured Guaranty-0.64
Genworth MI Canada-0.62
ProAssurance Corporation-0.58
TGS-NOPEC Geophysical-0.56

2 Net of dividends

Current Positioning And Outlook

We are optimistic about the outlook for dividend-paying small-cap stocks. Given that markets usually rotate and mean revert, we think investors may want to ask themselves if what has led the market for the past 10 years seems likely to lead for the next 10. Small-cap value stocks, whose relative valuations are near all-time lows relative to both small-cap growth and large-cap stocks, appear well positioned to benefit from that reversion movement.

While uncertainty about the pace and shape of an overall economic recovery continues to linger, trends within specific industries seem clearer. We have been reducing our exposure to specialty retail in favor of high-quality branded apparel businesses with durable, iconic brands and strong balance sheets because we see opportunities for these companies to take market share as the economy emerges from the pandemic. We have also reduced our weighting in Industrials in favor of increasing our exposure to select Information Technology holdings. The strong performance of holdings in capital markets, coupled with lagging results for banks and insurance companies, led us to reposition our industry weights in Financials. 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. In addition, we believe that property & casualty insurers may be at the onset of one of the strongest pricing cycles we’ve seen in several decades, a scenario not reflected in their valuations at the end of June. Finally, we began taking profits in certain equity exchange holdings that have outperformed most other areas of Financials.

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 cyclically oriented businesses with conservatively capitalized balance sheets and strong industry positions. The case is particularly strong in our view for select dividend payers in the small-cap space where 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 (%)

Total Return 18.56-17.33-11.49-0.403.328.386.048.249.49 12/15/93

Annual Operating Expenses: 1.25

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 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, other expenses, and acquired fund fees and expenses. 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 1.3%, Ares Management Cl. A was 1.6%, Gold Fields ADR was 1.0%, TMX Group was 1.3%, Virtu Financial Cl. A was 0.5%, CIT Group was 0.6%, Assured Guaranty was 0.7%, Genworth MI Canada was 0.8%, ProAssurance Corporation was 1.2%, TGS-NOPEC Geophysical 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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