How did the Small-Cap Premier Quality Strategy perform in 2Q23 and the first half of 2023?
Lauren Romeo: The mutual fund we manage in the Strategy, Royce Premier Fund, advanced 4.5% for the quarter, lagging its benchmark, Russell 2000 Index, which was up 5.2% for the same period. The Fund also decisively beat its benchmark for the year-to-date period ended 6/30/23, increasing 14.3% versus a gain of 8.1% for the Russell 2000 and outperformed the Russell 2000 for the 1-, 3-, 5-, 10-, 20-, 25-, 30-year, and since inception (12/31/91) periods ended 6/30/23.
What were the Fund’s results on a sector basis in 2Q23?
Steven McBoyle: Seven of the portfolio’s nine sectors made a positive impact on quarterly performance. The sectors making the largest positive contributions were Industrials, Materials and Information Technology while the only negative impacts came from Communication Services and Consumer Staples.
What happened at the industry level in 2Q23?
LR: Paper & forest products (Materials), machinery (Industrials), and capital markets (Financials) contributed most for the quarter, while technology hardware, storage & peripherals (Information Technology), professional services (Industrials), and interactive media & services (Communication Services) were the largest detractors.
How did the Fund perform relative to the Russell 2000 on a sector basis in 2Q23?
SM: The portfolio’s disadvantage versus its benchmark was attributable to stock selection in the quarter. However, hurting relative performance most was our lower exposure to Health Care--where stock selection also detracted, as it did in Information Technology and Industrials (where our larger weighting was a positive). Conversely, both stock picks and our lower exposure to Financials, stock selection in Materials, and having no exposure to Utilities contributed most to relative quarter results.
How did the Fund perform at the sector level for the year-to-date period ended 6/30/23?
LR: Eight of the Fund’s nine equity sectors made positive contributions to performance in 2023’s first half, led by Industrials, Information Technology, and Materials. Communication Services was the lone detractor while Health Care and Financials made the smallest contributions.
What were the biggest industry contributors and detractors in the first half of 2023?
HM: Machinery (Industrials), semiconductors & semiconductor equipment (Information Technology), and electronic equipment, instruments & components (Information Technology) contributed most for the year-to-date period, while professional services (Industrials), interactive media & services (Communication Services), and media (Communication Services) were the largest detractors.
Which holding contributed most for the year-to-date period ended 6/30/23?
LR: Stella-Jones (TSX:SJ, Financial) was the portfolio’s top contributor at the position level in 2023’s first half. The company dominates the railway tie and wood utility pole markets and has a growing residential treated lumber business. Stella-Jones has benefited from strong lumber prices and healthy home repair/remodel activity while demand for its rail ties remains largely recession-resistant as some percentage of the installed base is replaced annually as part of railroad track maintenance. Finally, it is seeing a dramatic upswing in utility pole demand, its largest segment, as broadband network expansion, renewable energy, and electric vehicle adoption are secular drivers of electricity usage and the need for utilities to harden their grids.
Which holding detracted most from performance in 2023’s first half?
SM: The Fund’s top detractor for that period was Lindsay Corporation (LNN, Financial), which provides center pivot irrigation systems for commercial agriculture. Lindsay’s stock retreated as corn and wheat prices came off highs and farm income is forecasted to decline from peak levels. The company also faces difficult year-over-year comparisons later this year because several severe storms in 2022 drove higher pivot-replacement demand. Internationally, Lindsay has faced irrigation order delays in the high growth Brazilian market due to a political transition that pushed out implementation of a government financing program for agricultural products growers.
What were the sources of the Fund’s advantage over the Russell 2000 in 2023’s first half?
LR: Premier’s advantage over its benchmark was primarily attributable to sector allocation in 2023’s first half. Financials, Materials and Consumer Staples made the most significant positive impact versus the benchmark while Communication Services and Health Care were the only detractors from relative results.
What is your outlook?
SM: In general, the outlook remains cloudy with further rate increases designed to curb falling but persistent inflation, continued recession fears, and a banking crisis still memorable to most investors. Cloudy outlooks, however, tend to provide opportunities for the Fund’s all-weather approach given our investments in durable business models that have strong histories of persistent high returns on invested capital, consistent free cash flow generation, and strong balance sheets. While the debate rages on about when the most predicted recession in our history will begin, evidence of decelerating inflation and Fed commentary on the prospect of a more measured pace of rate increases appeared to shift sentiment toward the view that any recession is likely to be mild. Accordingly in June, consistent with the market being a discounting mechanism, investors appeared to take steps to position for an eventual recovery, driving up returns for both the Russell 2000 and large-cap Russell 1000 Indexes, up 8.1% and 6.8%, respectively.
LR: Given our focus on bottom-up stock selection (as opposed to macro-led portfolio construction), our only forecast is that whatever economic environment prevails in the second half of 2023, we believe that the high-quality business models the Fund owns should continue to compound shareholder value. We also anticipate that, as this market cycle progresses, investors will increasingly focus on business fundamentals and valuations. We expect our companies to perform well during this period by leveraging their competitive advantages to pursue strategies such as gaining market share, expanding geographically, and/or consolidating via acquisitions during this uncertain time, as they have done in previous periods of uncertainty.
Ms. Romeo’s and Mr. McBoyle’s thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future. The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.
