Fund Performance:
Royce Global Financial Services Fund advanced 0.5% for the year-to-date period ended June 30, 2016, compared to a gain of 2.2% for its small-cap benchmark, the Russell 2000 Index, and an increase of 5.0% for the financial services component of the Russell 2500 Index for the same period. Small-cap share prices started 2016 in a dizzying decline through their year-to-date low on February 11. Stocks then rallied through the end of the first quarter. The Fund gained 1.9% in this volatile period outpacing both the Russell 2000, which fell 1.5%, and the Russell 2500 financial services companies, which were up 0.3%.
The second quarter saw an extension of the rally, but with some important sector and industry leadership shifts within small-cap. REITs and Utilities—two of the more resilient and successful areas within the Russell 2000 over the last couple of years—maintained their strong runs as other areas either decelerated or failed to participate. The Fund fell behind both indexes in the second quarter, down 1.4% versus respective gains of 3.8% and 4.7% for the Russell 2000 and the financial services component of the Russell 2500. This was primarily due to poor second-quarter results for capital markets, by far the portfolio’s largest industry and a perennial area of investment focus, which were disproportionately affected by Brexit. Its effects elsewhere in the U.S. equity market were otherwise more quickly shaken off.
WHAT WORKED… AND WHAT DIDN’T
The Fund’s significant overweight in capital markets was therefore the biggest factor in relative underperformance. We view the capital markets industry as highly diverse, which is one reason we frequently find attractive opportunities there. The portfolio’s holdings in this industry include both domestic and international traditional asset managers, alternative asset managers, investment banks, wealth management firms, and specialist vendors to the industry. While we remain confident in the long-term prospects of our holdings, shorter-term periods, especially volatile ones, can affect these stocks disproportionately. Discount brokerage leader The Charles Schwab Corporation (SCHW, Financial) was the Fund’s biggest detractor in the first half, mostly the result of the post-Brexit expectation that interest rates will remain low for an extended period, which could create a challenge for Schwab as its profits could be expected to improve with rising rates. Based in the United Kingdom, Jupiter Fund Management (LSE:JUP, Financial) is an asset manager with a focus on retail investors. Its shares fell sharply after the Brexit vote, though that did little to alter our view of Jupiter as one of the U.K.’s better asset management firms. Och-Ziff Capital Management Group (OZM, Financial) is an institutional alternative asset manager that offers multi-strategy, credit, equity, and real estate funds. Its stock declined as the company worked through poor short-term investment performance in key funds and an ongoing Department of Justice investigation into certain international fundraising activities. We believe that investment performance will rebound and that the DOJ investigation will conclude with manageable civil fines.
The Fund’s best performer in the first half was Franco-Nevada Corporation (FNV, Financial), a Canadian gold-focused royalty company with a large and diversified portfolio of cash-flow producing assets. The company paid down debt, increased its dividend, and offered upward earnings revisions, all as gold prices surged during the first half. Two stock exchange operators were among the top first-half contributors. Brazil’s BM&F Bovespa (BSP:BVMF3)Â is a top-10 holding that bought rival Cetip in April, creating the largest exchange in Latin America, with a presence from Mexico to Chile. Its stock rose on the news as well as on fiscal first quarter revenue, margin, and earnings improvements. TMX Group (TSX:X, Financial) owns and operates the Toronto Stock Exchange. The company reported decent earnings and offered evidence of transforming its business model to a lower cost base with a broader base of revenue streams.
Top Contributors to Performance
- Franco-Nevada Corporation - 1.05%
- BM&F Bovespa - 0.95%
- TMX Group - 0.70%
- U.S. Global Investors Cl. A (GROW, Financial) - 0.65%
- FirstService Corporation (FSV, Financial)- 0.56%
Top Detractors from Performance
- Charles Schwab (The) Corporation - (-0.52%)
- Jupiter Fund Management - (-0.50%)
- Och-Ziff Capital Management Group LLC Cl. A - (-0.39)
- Stifel Financial (SFB, Financial) - (-0.33)
- Financial Engines (FNGN) - (-0.33)
CURRENT POSITIONING AND OUTLOOK
At the end of the semiannual period, the U.S., Canada, and the U.K. were our largest country exposures, accounting for about 75% of net assets. However, highlighting the geographic reach of the portfolio, we held positions located in another 20 countries, none of which individually amounted to 3% of net assets. Based on our proprietary classification we held about two-thirds of the portfolio in five categories: traditional asset managers, alternative asset managers, specialist vendors, exchanges, and banks. During the first half, we reduced our weighting in traditional asset managers in favor of credit-focused alternative asset managers, trimmed our exposure to U.S.-based wealth managers, and increased our investments in selected real estate-related firms headquartered outside the U.S. We have constructed a portfolio of what we consider to be differentiated franchises with attractive business models and low capital requirements in a specialized area where we think our experience gives us an analytical advantage. We believe the long-term outlook for these companies is promising.
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