Premier Fund underperformed the Russell 2000 Index for the calendar year but beat the benchmark for the five-, 15-, 20-, 25-year, and since inception (12/31/91) periods ended 12/31/20.
Royce Premier Fund did well on an absolute basis in 2020, though it lagged its benchmark for the year, advancing 11.5% compared to 20.0% for the Russell 2000 Index, snapping a streak of four consecutive years of beating its benchmark. Relative results over longer-term periods were better as Premier tied its benchmark for the three-year period, while beating the small-cap index for the five-, 15-, 20-, 25-year, and since inception (12/31/91) periods ended 12/31/20. The leadership of low-quality stocks since the market's mid-March bottom, including those with low returns on equity and/or no earnings, created a difficult environment for the Fund's high-quality strategy.
What Worked And What Didn't
For the full year, the largest sector contributor by far was Information Technology, followed by Health Care, a duo that led seven equity sectors with positive performance. Energy and Real Estate were the only two of the nine sectors where the Fund held investments that posted losses for the year.
Investment information specialist Morningstar (MORN, Financial) was the top individual contributor for the year, though much of its advance came in the fourth quarter when its shares climbed more than 50% after the company reported solid quarterly operating results with expanding operating margins and notable revenue growth from recent acquisitions. We believe Morningstar's leadership position in providing data, software, and other tools designed to improve investment decision making and serve advisors and financial institutions should only increase with a growing global investment class.
Quaker Chemical (KWR, Financial), a global leader in industrial process fluids, followed in second place. Its business was a direct beneficiary of the global industrial recovery toward the end of 2020, when all of its business segments returned to growth, driven primarily by the global rebound in automotive production. We believe the company is still in the early stages of a multi-year opportunity, especially because Quaker serves diverse industrial end markets on a global scale and is thus poised to benefit from a worldwide economic recovery as well as from its ongoing efforts to pay down debt and a possible return to the M&A market.
In a very difficult year for energy-related stocks, Canada's Pason Systems (TSX:PSI, Financial) was the portfolio's largest individual detractor. The company, which provides oil field instrumentation largely for onshore rigs, suffered as U.S. rig counts plummeted along with the price of oil in the second quarter before managing a modest recovery in the fourth quarter. The company has a solid balance sheet, a pipeline of new products in the early stages of roll-out, and an excellent competitive position, which lead us to believe it can gain market share in the next energy rebound. We had less confidence in the long-term prospects for Norway's TGS-NOPEC Geophysical (OSL:TGS, Financial), which we exited in October. The company provides geophysical marine seismic data to oil exploration companies and was the second-largest detractor on a position basis. While we like TGS-NOPEC's business model, we believe that structural changes in oil & gas exploration, as well as secular shifts toward cleaner energy, will ultimately reduce its long-term growth and consequently the rate at which it can compound value.
The Fund's relative disadvantage in 2020 was due entirely to lagging stock selection as sector allocation decisions were additive. Health Care led the detractors, mostly due to our underweight in this leading sector, though stock selection also hurt. The bulk of our underperformance came from having no exposure to the biotechnology industry, one of the best performing areas within small cap. Industrials was the second largest source of underperformance, owing to lackluster stock selectionsector allocation was positive. Conversely, Financials helped performance versus the Russell 2000 in 2020, largely due to superior stock selection, though underweighting this lagging sector also helped. The top relative industry contribution came from having no exposure to banks, which posted negative results for the year. Real Estate also contributed to relative results as we also were underweighted in that trailing sector.
Top Contributors to Performance20201 (%)
|Ritchie Bros. Auctioneers||1.30|
1 Includes dividends
Top Detractors from Performance20202 (%)
|Genworth MI Canada||-1.22|
2 Net of dividends
Current Positioning and Outlook
We are guardedly optimistic about small caps enjoying a positive year in 2021. Based on history, it is rare for the asset class to see major declines in the absence of a recession or aggressive Fed actions, and neither looks likely in 2021. At the same time, highly positive expectations have driven the recent rally. While we suspect that this small-cap cycle has further to go, we also know that history suggests a 10-15% correction is more probable than not at some point in 2021. We are equally aware that the Fund lagged its benchmark in 2020, though that too follows a typical historical pattern. In the first year of market rebounds, the lowest profitability companies often outshine those with higher profitability. However, as market cycles progress, leadership often rotates to the type of higher profitability companies that Premier favors. We look forward to taking advantage of whatever volatility the market provides and are ready to invest in what we regard as superior businesses at temporarily depressed prices.
Average Annual Total Returns Through 12/31/20 (%)
Annual Operating Expenses: 1.19
1 Not annualized.
Important Performance and Disclosure Information
Important Performance and Expense Information
All performance information reflects past performance, is presented on a total return basis, reflects the reinvestment of distributions, and does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, so that shares may be worth more or less than their original cost when redeemed. Shares redeemed within 30 days of purchase may be subject to a 1% redemption fee, payable to the Fund which is not reflected in the performance shown above; if it were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained at www.royceinvest.com. Operating expenses reflect the Fund's total annual operating expenses for the Investment Class as of the Fund's most current prospectus and include management fees and other expenses.
Current month-end performance may be obtained at our Prices and Performance page.
Notes to Performance and Other Important Information
The thoughts expressed in this report concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at December 31, 2020, and, of course, historical market trends are not necessarily indicative of future market movements. Statements regarding the future prospects for particular securities held in the Funds' portfolios and Royce's investment intentions with respect to those securities reflect Royce's opinions as of December 31, 2020 and are subject to change at any time without notice. There can be no assurance that securities mentioned in this report will be included in any Royce-managed portfolio in the future.