Portfolio managers Boniface (Buzz) Zaino and Bill Hench are using turbulent economic conditions to find highly promising ideas. With their unique opportunistic value approach, they focus on small-cap and micro-cap companies, those with market capitalizations up to $2.5 billion.
What sets the Royce Opportunity Fund (ROF) apart from the rest of The Royce Funds?Royce Opportunity Fund invests utilizing four themes that have served as the basis for my investment process for more than 40 years. The types of companies that Bill and I like to look at include:
- Turnaround stories or companies recovering from depressed operating margins due to management changes or industry – and/or sector-specific factors.
- Undervalued growth or companies we believe can provide potential growth rates of at least 12%, have strong balance sheets and whose stock prices are selling at valuations that are low relative to comparable securities.
- Unrecognized asset values or companies selling below probable liquidating value, franchise value, tangible book value or physical asset value relative to plant or liquid assets.
- Interrupted earnings, companies that have the potential for either a 20% annual growth rate or preeminent market position, accompanied by a price-earnings multiple substantially less than the expected growth rate.
So as the name implies, Royce Opportunity Fund may appeal to opportunistic investors who can accept a more volatile road to potentially higher returns?Historically, the Fund has experienced higher volatility than its small-cap benchmark, the Russell 2000 Index. Over various time periods, ROF has tended to participate in both the upside of a rallying market as well as the declines of a bear. However, while the road can be a little rocky at times, we think that investors with long-term time horizons can benefit.
Contributing to some of both the higher highs and the lower lows is the fact that we constantly seek out companies with share prices that have been beaten down for one reason or another. Micro-cap companies, those with market capitalizations up to $750 million, tend to be hit harder during difficult times and so are typically more volatile than larger companies. As of March 31, 2012, micro-cap stocks made up almost 50% of the Fund's net assets.
The Fund is highly diversified, with more than 300 holdings and not one name in the top ten hitting much more than 1.0% of net assets. Describe your very deliberate process of slowly moving into and out of positions.It's critically important for us to spread risk across the portfolio rather than load up on a handful of names, which is part of why we suggest investors have a long-term investment horizon of at least three years. We build positions slowly, particularly as prices go down. It can take several quarters of disappointment, and additional price erosion, before a company begins to turn around.
We spend years getting to know companies and their management teams so that we can better determine whether their problems are resolvable and a company can potentially return to normalized earnings or whether something fundamental has changed. Invariably, there will be a handful of large winners as well as a few large losers, but it's the performance of the portfolio as a whole that counts.
Too often people overlook the fact that performance is ultimately a function of the price you paid to buy a share and the price at which you later sold the share. We can't begin to guess when the next trough or peak will be, so regardless of the asset class, any investor, even portfolio managers of billion dollar funds, can benefit from dollar-cost averaging.
What are your thoughts on the current market environment and potential for more quantitative easing?The strength of the equity rally that started in October and continued through March of this year was most likely exaggerated by the mild winter. The recovery is clearly not as strong as we'd all like it to be, though we remain confident in several areas, for example, homebuilders; we think they operate on a three-year cycle with ups and downs in between.
With interest rates already so low, whether you are a company or a consumer, it's never been cheaper to borrow. We don't believe another round of quantitative easing will make much difference. But our job is to look past the short-term noise. Investors have a habit of reacting to their most recent memory, which has not been pleasant. For those of us with a longer-term time horizon, the shortsightedness of others allows us to buy companies at distressed prices while those folks overreact to the downside. As we experienced in the aftermath of 2008, a weak market is often where the most money is made.
Bill Hench also serves as portfolio manager of Royce Opportunity Select Fund (with Buzz Zaino) which utilizes the same four investment themes as Royce Opportunity Fund, but has the additional ability to sell short securities representing up to 35% of its net assets and may employ leverage. Royce Opportunity Select Fund is available only to "qualified investors".
Important Disclosure Information
The thoughts expressed here are solely those of the person speaking and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.
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. Royce Opportunity Fund invests primarily in small-cap and micro-cap stocks, which may involve considerably more risk than investing in larger-cap stocks (Please see "Primary Risks for Fund Investors" in the prospectus.)
Distributor: Royce Fund Services, Inc.