Fund performance
Royce Global Financial Services Fund fell 4.7% in 2015, compared to a loss of 4.4% for its small-cap benchmark, the Russell 2000 Index, and a gain of 3.1% for the financial services component of the Russell 2500 Index for the same period. The first half of the year was better than the second. For the year-to-date period ended June 30, 2015, the Fund advanced 7.2%, easily outperforming both its smallcap benchmark, which was up 4.8%, and the Russell 2500 Financial Services Index, which was up 3.1% for the same period.
A sweeping correction hit the equity markets in the third quarter, when Global Financial Services was down 10.2% versus a loss of 11.9% for the Russell 2000. The financial services companies in the Russell 2500, however, lost only 3.7% in the third-quarter downturn, helped in part by banks and REITs, which defended better than most other areas. The Fund’s substantial weighting in capital markets companies, a perennial area of investment focus, hurt relative results versus small- and mid-cap financial companies. Equities rebounded in the fourth quarter, but the Fund did not participate, falling 1.1% versus an increase of 3.6% for the Russell 2000 and 3.8% for the Russell 2500 Financial Services Index. Stock selection in the capital markets and diversified financial services group detracted most from relative performance in the year’s last three months.
What worked … and what didn't
Our strategy with the Fund rests on four propositions that grow out of our somewhat unique take on the financial services sector: Select areas of financial services, along with their suppliers, look more likely to us to grow faster than the overall economy over the long term. Certain business models in the sector, including those of asset managers, investment banks, niche lenders, exchanges and specialist service providers, are attractive because of their high returns on invested capital and ability to differentiate themselves. Their often complex business models and the companies’ cyclical earnings patterns also often lead to them being misunderstood — and thus mispriced — by investors, which can create opportunities for active managers. Our many years of experience as an asset manager provide ample insight into the particular dynamics of these businesses.
We were disappointed in overall results for the capital markets group in 2015, though we still think highly of the recovery potential and long-term prospects for a number of our holdings in the industry. Eight of the portfolio’s 10 most significant detractors came from the group, which also accounted for five of our 10 largest contributors. At the position level, Medley Management posted the largest net losses. This Manhattan-based asset manager focuses on yield-oriented products for institutional and retail investors. Its shares suffered most in the year’s second half as third-quarter earnings, energy exposure and a reduced management fee for one of its business development companies all disappointed investors. Dundee Corporation is a holding company based in Toronto that is involved in investment advisory, corporate finance, energy, resources, agriculture, real estate and infrastructure. The company also holds investment portfolios in these areas. Its stock was hurt most by significant exposure to the weakened commodity markets in 2015. We held small positions in both companies at year end.
Turning to the positive side, two asset managers led the Fund’s list of contributors by an impressive margin — Diamond Hill Investment Group (DHIL, Financial), an independent investment adviser located in Columbus, Ohio, and ETF specialist Wisdom Tree Investments (WETF, Financial).
Top contributors to performance for 2015 (%)
- ”‹Diamond Hill Investment Group 0.67%.
- WisdomTree Investments 0.65%.
- MarketAxess Holdings (MKTX, Financial) 0.46%.
- MSCI (MSCI, Financial) 0.40%.
- Xoom Corporation (XOOM, Financial) 0.39%.
Top detractors from performance for 2015 (%)
- Medley Management Cl. A (MDLY, Financial) -0.84%.
- Dundee Corporation Cl. A (DC.A, Financial) -0.75%.
- Fifth Street Asset Management Cl. A (FSAM, Financial) -0.73%.
- U.S. Global Investors Cl. A (GROW, Financial) -0.67%.
- Coronation Fund Managers (CML, Financial) -0.56%.
Current positioning and outlook
Effective June 15, 2015, we renamed the Fund while simultaneously expanding its ability to invest in non-U.S. financial services companies, which have become an area of increasing interest and opportunity for us over the last several years. At year end the Fund’s most significant exposure outside the U.S. was in the U.K., Canada and Switzerland. While more than half of the portfolio is categorized in the capital markets industry, investors should be aware that we see considerable diversity within this group, which encompasses both traditional and alternative asset managers and institutional and retail brokerage firms based in the U.S., as well as international asset management, wealth management and investment banking firms.
As a result, the portfolio’s industry emphasis is very different from that of the financial services companies in the Russell 2500, and we would expect the Fund to remain periodically out of sync with it and to often move in a different direction than the Russell 2000. During the year, we increased exposure to alternative asset managers, primarily those involved in private equity, private credit and real estate.
We believe that several are well positioned to take advantage of how major regulatory legislation has reshaped the financial services landscape. We also added selectively to specific situations where leading niche financial companies saw their stock prices decline for what we see as temporary causes. Finally, we added to certain holdings where we view management as making steady, profitable progress, while trimming others where we came to the opposite conclusion.
