Royce International Micro-Cap Fund increased 0.2% for the year-to-date period ended June 30, trailing its benchmark, the Russell Global ex-U.S. Small Cap Index, which rose 1.0% for the same period. During the first quarter, results for non-U.S. micro- and small-caps were mixed, though mostly muted, with one of 2015’s strongest groups — those in developed Europe — correcting most sharply.
Although the portfolio’s exposure to Western Europe was higher than that of its benchmark, International Micro-Cap nonetheless outperformed, advancing 2.5% compared to a 0.9% gain for the Russell Global ex-U.S. Small Cap. Holdings in Canada and Brazil contributed most to quarterly performance.
The second quarter looked mildly bullish until the Brexit decision upended many markets, particularly those in the eurozone. By the end of June, most had still not recovered, unlike many of their counterparts in other regions of the globe. The fund underperformed the Russell Global ex-U.S. Small Cap in the second quarter, down 2.2% compared to a 0.1% advance for its benchmark. The entirety of its second-quarter loss came during the final week of June — a disappointing end to what had been a modestly positive quarter prior to the Brexit decision. We were pleased, however, that the fund outperformed its benchmark for the three-year period ended June 30.
What worked and what didn’t
Six of the fund’s eight equity sectors finished the first half with net gains. The biggest contributions came from Consumer Discretionary, Financials and Materials while Energy and Consumer Staples detracted. The top industry group was media (Consumer Discretionary) followed by real estate management and development (Financials) and semiconductors and semiconductor equipment (Information Technology). The fund’s three largest detractors at the industry level were oil, gas and consumable fuels (Energy), specialty retail (Consumer Discretionary) and banks (Financials).
Banca Sistema (MIL:BST, Financial) is an Italian bank specializing in financing and managing trade receivables owed by the Italian Public Administrations. Despite its unique business model and attractive growth profile, it has been caught up in the widespread downdraft for Italian banks, considered one of the more vulnerable areas of European finance in the aftermath of Brexit. While we suspect there may be increased volatility in the short run, we added shares based on our confidence in its long-term prospects.
Ardmore Shipping (ASC, Financial) owns and operates shipping tankers, primarily for chemicals. With shipping index volumes bouncing along all-time lows during the first half of the year, its stock was not spared. However, the fact that it was trading at about half its book value near the end of June made Ardmore worth holding as we await a recovery for its industry.
Top-10 position T4F Entretenimento (BSP:SHOW3, Financial) is a Brazilian company that operates at multiple levels of the entertainment industry including venue operation, ticketing, food and beverage, merchandise sales and corporate sponsorships. The company has exceeded earnings-per-share expectations for the past three quarters. Recent share price appreciation notwithstanding, we think it continues to be vastly undervalued relative to its global peers, mainly because most of its business is in Brazil, which has had political and economic uncertainty over the last couple of years.
Manappuram Finance (BOM:531213, Financial) is an Indian finance company that makes small loans to consumers collateralized by gold. Its shares more than doubled between March and the end of June, mainly the result of achieving synergies from past branch expansion just as gold prices soared. Morneau Shepell (TSX:MSI, Financial) is a Canadian pension and human resource consultant that saw new business-boosting revenue and earnings in its fiscal first quarter.
Holdings based in Canada had by far the biggest positive impact on first-half results, followed by Brazil, India and Japan while the largest detractor by far on a country basis was the United Kingdom (with Brexit obviously hurting a great deal) followed by Italy. In addition to Morneau Shepell, Magellan Aerospace (TSX:MAL, Financial), which serves the civil aerospace and defense markets, was a strong Canadian contributor.
Relative to the Russell Global ex-U.S. Small Cap, the fund was hurt most by ineffective stock selection in the previously mentioned oil, gas and consumable fuels group and our lighter weighting in the metals and mining industry within Materials. Stock picking and our underweight in Consumer Staples were also factors in underperformance. Conversely, stock picking was a substantial strength in media (Consumer Discretionary), real estate management and development (Financials) and professional services (Industrials).
Top contributors to performance
- T4F Entretenimento 1.10%.
- Manappuram Finance 0.52%.
- Morneau Shepell 0.51%.
- Magellan Aerospace 0.39%.
- Webjet 1 (ASX:WEB) 0.35%.
Top detractors from performance
- Banca Sistema -0.66%
- Ardmore Shipping -0.51%
- Zealand Pharma (OSCE:ZEAL) -0.41%
- Pendragon (LSE:PDG) -0.36%
- SPARX Group (TSE:8739) -0.34%
Current positioning and outlook
Despite continued market volatility, we see pockets of opportunity in several regions. Recent events in the U.K. have led to wide dislocations between the business value and stock price in many European microcaps. In Japan, negative interest rates, as well as ongoing urbanization, have created a positive tailwind for real estate companies while India remains the sole global economy growing in the high single digits. Its finance market is also still relatively immature and should continue to see positive momentum. In addition, we are finding discrete opportunities in businesses affected by the slowdown of the Chinese economy that have used the opportunity to right-size their cost bases to reflect more realistic growth assumptions.
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