FUND PERFORMANCE
Royce Opportunity Fund was down 13.6% in 2015, behind its small-cap benchmark, the Russell 2000 Index, which declined 4.4% for the same period. The Fund finished the year-to-date period ended June 30, 2015 with a gain of 0.7% versus an increase of 4.8%. This period looked stronger than it was for small-caps considering how narrow market leadership was—most of its strength came from Health Care, specifically biotech. When the market began to subsequently correct in the third quarter, however, the decline was more far reaching, and the Fund fell 15.5% while its benchmark was down 11.9%. Stocks recovered a bit in the year’s final quarter, in which the portfolio advanced 1.6% compared to a 3.6% increase for the Russell 2000, capping off a difficult year. We are, however, confident as we look forward to 2016. We were also pleased that Opportunity Fund outpaced the small-cap index for the 15-year and since inception (11/19/96) periods ended December 31, 2015. The Fund’s average annual total return since inception was 11.4%, a long-term record that gives us great pride.
WHAT WORKED… AND WHAT DIDN’T
Eight of the portfolio’s 10 equity sectors finished the year in the red, with Consumer Discretionary, Industrials, Materials, and Information Technology detracting most. With exception of Materials, these are typically our largest sector weightings, as they were at the end of 2015. At the industry level, four groups accounted for a large share of the Fund’s net losses. Metals & mining stocks detracted most, with Century Aluminum, which produces the metal, and Noranda Aluminum Holding, another producer that focuses on building construction, architectural, and transportation uses, showing the largest net losses. China’s decision to export its excess capacity has kept aluminum prices low. In the specialty retail group, individual company losses were more diffuse, as they were for electronic equipment, instruments & components companies and machinery stocks. The first of these groups has had to cope with declining mall traffic and a highly selective U.S. consumer.
UniSys Corporation (UIS, Financial) was another significant detractor. In our view a long-term turnaround candidate, the company brought on new management late in 2014 who were charged with restructuring its IT services business that focuses on systems integration, outsourcing, infrastructure, server technology, and consulting. We built our position through much of 2015. Online lender Enova International (ENVA, Financial) offers short-term consumer and installment loans in the U.S., U.K., Australia, and Canada. Having survived a period of government scrutiny into its industry, it looks poised to benefit from a rising interest rate environment. Northwest Pipe (NWPX, Financial) makes large-diameter, high-pressure steel pipe products used for water transmission.
It also moved into the oilfield country tubular goods market close to the time energy prices began to plummet, which hurt growth and revenues. It’s moving out of that business and concentrating on what we think it does best, making us confident in its recovery potential.
On the positive side, there were 16 portfolio companies that were acquired in 2015, which is good news not only for the premiums we received but also for the message that our valuation analyses were sound. RTI International Metals specializes in titanium and other metals and sells primarily to the aerospace industry. Its shares shot up quickly in March when Alcoa (AA, Financial) announced an agreement to buy the company. Better-than-expected revenues helped the stock price of RF and mixed-signal integrated circuit specialist MaxLinear to climb in 2015 while earnings strength drove the rising share price of NeoPhotonics Corporation, which makes hybrid photonic integrated optoelectronic modules and subsystems for high-speed communications networks.
A welcome fourth-quarter rebound was not enough to keep the Information Technology sector from detracting most on a relative basis for the calendar year, primarily due to stock selection in IT services and electronic equipment, instruments & components companies. The Fund suffered versus the benchmark from both our overweight and stock selection misses in Materials and from ineffective stock selection in Consumer Discretionary. A sizable disadvantage also came from its underweight in Health Care while lack of exposure to Energy provided an advantage.
Top Contributors to Performance For 2015 (%)
- RTI International Metals (RTI) 0.36%
- MaxLinear Cl. A (MXL) 0.34%
- NeoPhotonics Corporation (NPTN) 0.32%
- U.S. Concrete (USCR) 0.29%
- Central Garden & Pet (CENT) 0.27%
Top Detractors from Performance For 2015 (%)
- Century Aluminum (CENX, Financial) -0.66%
- Unisys Corporation (UIS, Financial) -0.49%
- Enova International (ENVA, Financial) -0.49%
- Northwest Pipe (NWPX, Financial) -0.38%
- Noranda Aluminum Holding Corporation (NORNQ) -0.37%
CURRENT POSITIONING AND OUTLOOK
Our large weights in Information Technology, Industrials, and Consumer Discretionary are consistent with our view that valuations for the majority of our portfolio holdings look attractive to us and are poised to benefit from ongoing U.S. economic growth. We expect the increased federal spending and business tax credit plans passed in anticipation of the 2016 elections to boost the pace of growth in the U.S., which should help areas such as nonresidential construction, defense, consumer, and technology. With so much recent attention on China, we think it’s important to point out that the U.S. remains by far the world’s largest economy. We expect improvements here at home to ultimately ripple out to other parts of the globe. However, we think the greater domestic focus of most small-cap stocks, specifically many that we hold, will be a positive while we wait for a stronger, steadier pace of economic growth.
