For the year-to-date period ended June 30, 2015 Royce Select Fund I was up 0.2% versus a gain of 4.8% for its small-cap benchmark, the Russell 2000 Index, for the same period.
This was a disappointing outcome, though it was not entirely surprising in the context of a market that saw the bulk of its leadership in 2015’s first half come from highgrowth industries, such as biotech, while more economically sensitive sectors had not yet revved up by the end of June.
Stocks as a whole began the year with losses, with January being a decidedly bearish month across asset classes. Most stocks went on to recover through the rest of the first quarter and pushed past their earlier losses. In the first three months, Select Fund I managed a small gain of 0.2% compared to the 4.3% advance for the Russell 2000. When the markets reversed again in April, we were pleased to see the Fund post a small gain for that otherwise dismal month. Growth issues again emerged with momentum, however, through most of May and June. For the second quarter, the Fund was flat while its benchmark gained 0.4%. We were pleased that Select Fund I outpaced the Russell 2000 for the 10-, 15-year, and since inception (11/18/98) periods ended June 30, 2015. The Fund’s average annual total return since inception was 12.9%.
WHAT WORKED… AND WHAT DIDN’T
The portfolio’s underweight in the Health Care sector was the primary driver of its underperformance. The sector ruled the market roost in the first half, which held true for equities as a whole, for small-cap as an asset class, and for the portfolio—with one important difference. The Fund had very limited exposure to biotech issues—the leader within small-cap by a quite sizable margin. This meant the sector was something of a double-edged sword to the portfolio in the semiannual period—its net gain was critical but its impact was negative compared to the lofty returns achieved in the benchmark. The Fund’s successes in Health Care came largely from one holding in the pharmaceuticals industry and a second in the life sciences tools & services group. Lannett Company manufactures generic drugs. The firm was aggressive with pricing and took advantage of limited competition in certain drugs to exceed Wall Street expectations. We like its growing pipeline of generics awaiting approval, which are critical to its future growth once Lannett begins to anniversary the price increases on its core medications. Bio-Rad Laboratories provides life science research products, clinical diagnostics, and analytical instrumentation. Its shares grew healthier on margin improvement in the first quarter in spite of ongoing modest organic growth. The company saw a payoff from consolidating facilities, reducing costs, and exiting some unprofitable lines over the past couple of years. These efforts should set the stage for material operating leverage when the headwinds of pricing pressure in Europe eventually abate. We also think its planned product rollouts for the second half of 2015 should also help to reaccelerate top-line growth.
Cal-Maine Foods (CALM) is the country’s largest producer and distributor of eggs. Prices have more than doubled in anticipation of constricted supply resulting from a major outbreak of avian flu in the Midwest, which led to the loss of approximately 11% of egg-laying hens, while greater demand has been keyed by higher prices for competing proteins such as beef, quick-service restaurants expanding their breakfast menus, and the popularity of high-protein diets. Additionally, the price of grain, the main input for egg producers, remains low. SEI Investments provides technology solutions and asset management to a range of institutional clients. Double-digit growth in assets under management and administration, which came from both capital market appreciation and gaining new clients, led its stock upward. While initially slow, we think the gradual adoption of the company’s Wealth Platform within the U.S. banking sector offers significant margin expansion potential.
Silicon Graphics International (SGI) detracted most from first-half results at the position level. The company runs a global business producing data storage, computing servers, and infrastructure software. It reported strong bookings but also reduced guidance, with revenues being pushed out to future quarters. In addition, the company discouraged investors with a short-term debt-financing deal earlier this year. We sold our position in ADTRAN, which makes high-speed digital transmission products. We simply lost patience after waiting several quarters for sales of telecom equipment to AT&T to begin producing revenue for ADTRAN. Specialty athletic and footwear retailer Genesco ran into difficulties trying to turn things around at its Lids licensed sports cap and Lids Locker Room licensed sports apparel businesses, which hampered results for the company as a whole.
Top Contributors to Performance
- Cal-Maine Foods (CALM)
- Lannett Company (LCI)
- Bio-Rad Laboratories Cl. A (BIO)
- SEI Investments (SEIC)
- John Bean Technologies (JBT)
Top Detractors from Performance
Silicon Graphics International -0.47
- ADTRAN (ADTN)
- Genesco (GCO)
- Unit Corporation (UNT)
- Oil States International (OIS)
IMPORTANT INFORMATION
The shareholders of Royce Select Fund I recently approved a reorganization that would combine that Fund with Royce 100 Fund. It is currently expected that the reorganization will be completed in August of 2015. Upon completion, shareholders of Royce Select Fund I will become shareholders of Royce 100 Fund and Royce Select Fund I will cease operations. You may review the proxy statement or go to www.roycefunds.com for more information.
