Royce Investment Partners Commentary: Penn--2Q21 Strategy Update and Outlook

By Chuck Royce, Steven McBoyle and Andrew Palen

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Sydnee Gatewood
Jul 22, 2021


  • We asked Chuck, Steven, and Andrew to update clients on the portfolio’s recent performance and explain their optimistic outlook.
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How did Royce Pennsylvania Mutual Fund perform in 2Q21?

Chuck Royce (Trades, Portfolio) The Fund advanced 2.8% in 2Q21 and trailed its benchmark, the Russell 2000 Index, which was up 4.3% for the same period. For the year-to-date period ended in June, Penn rose 16.6% versus a 17.5% gain for the benchmark, which is a terrific absolute return for any six-month period, even though we lagged the index a bit for that period. We’ve noted to our investors previously that, due to Penn’s high weighting in higher-quality companies, we have often lagged when small caps surge ahead in a relatively compressed time period. In spite of some recent relative performance challenges, we were also pleased that the Fund maintained its longer-term advantage. Penn beat its benchmark for the 20-, 25-, 30-, 35-, and 40-year periods ended 6/30/21.

Can you give us some details on the Fund’s sector results in 2Q21?

Steven McBoyle We were invested in 10 equity sectors during the second quarter, and each one finished the quarter in the black. The largest positive contributions came from Information Technology, Health Care, and Financials while the smallest came from Consumer Staples, Communication Services, and Real Estate—three of the portfolio’s four lowest sector weightings.

What happened at the industry level during the second quarter?

Andrew Palen Our three top contributors were a diverse group: semiconductors & semiconductor equipment from Information Technology, hotels, restaurants & leisure in Consumer Discretionary, and capital markets, which is in Financials. The industries that detracted most, on the other hand, all came from the Industrials sector, which lagged the Russell 2000 overall: road & rail, construction & engineering, and building products. We should note that we’re constructive on the long-term prospects for each of these three groups and remain bullish on the sector as a whole.

What position contributed most for the second quarter?

AP The top contributor in the second quarter was Scientific Games (

SGMS, Financial). The company develops, manufactures, and distributes a host gaming, lottery, sports betting, and other information-based products and services. It’s seen improvement for its newer product launches and beat earnings expectations for its fiscal first quarter of 2021. We also like that it’s paid down debt and has products and services that we think could potentially be profitably spun off.

Which holding detracted most for 2Q21?

SM The position that created the biggest drag on performance was Upland Software (

UPLD, Financial), which is a company that provides cloud-based enterprise work management software. Back in May, Upland reported results that exceeded expectations, showing increased growth and strong free cash flow. The company also completed two accretive acquisitions recently—Second Street and BlueVenn. We remain attracted to Upland’s mission critical B2B software tools, its strong customer relationships (98% net retention), and the way it consistently executes M&A. Despite these positive developments, the stock began to fall during May—but this peculiar dynamic is fairly consistent with previous reactions around the company’s earnings. For our part, we were pleased with the results and continue to think highly of its long-term prospects.

How did the Fund stack up relative to the Russell 2000 in 2Q21?

CR Our disadvantage came from both stock selection and sector allocation. The former had a bigger impact. Our lower exposure and ineffective stock picking hurt our relative results in Communication Services. I should probably add that this sector was dominated by meme stocks in the quarter. Our larger weighting in Industrials and a combination of poor stock picks and lower exposure to the resurgent Energy sector also detracted. On the other hand, savvy stock selection and our lower weighting were both additive in Health Care, which trailed the index as a whole. We also made effective stock picks and had lower exposure in Financials, as well as a lack of exposure to Utilities—each sector was an additional source of outperformance, especially because both lagged the Russell 2000 in 2Q21.

Can you talk about which sectors had the greatest impact on the portfolio for the year-to-date period ended 6/30/21?

SM Each of the 10 equity sectors where we had investments made positive contributions to performance. The largest came from Industrials, Information Technology, and Consumer Discretionary, while the smallest were in Communication Services, Consumer Staples, and Energy. These last three were the portfolio’s lowest sector weightings for the six-month period.

What was notable about year-to-date performance at the industry level?

AP At the industry level, our top contributors were semiconductors & semiconductor equipment, banks—which are in Financials and were very strong in 1Q21—and electronic equipment, instruments & components, another group in Information Technology. We were pleased that only three industries finished the year-to-date period in the red: health care technology from Health Care, metals & mining in the Materials sector, and consumer finance from Financials.

What position contributed most in the first half of 2021?

SM Our top contributor for the first half was Kulicke & Soffa Industries (

KLIC, Financial), which designs and manufactures capital equipment, related spare parts, and packaging materials used in semiconductor device assembly. The company reported strong results for its fiscal second quarter in May, citing increased global reliance on semiconductors and the growing capital intensity within the assembly process as the primary drivers behind its recent success.

Which holding detracted most for the same first-half period?

AP The top detractor at the position level was GCM Grosvenor (

GCMG, Financial), an investment management company focused on private equity, infrastructure investments, real estate, credit finance, and absolute return. Its shares fell after the company reported fiscal first-quarter results in mid-May that showed better-than-expected revenues but earnings that seemed to fall short of other investors’ expectations. We added shares through most of the first half.

What sectors did the most to help or hurt the Fund’s year-to-date results vis-à-vis the Russell 2000 Index?

SM Relative to the Russell 2000 for the year-to-date period, our underperformance came entirely from stock selection—our sector allocation decisions had a modestly positive effect. What hurt our relative results most at the sector level was a combination of lower exposure and ineffective stock selection in both Energy and Communication Services. In Materials, we had a positive effect from our higher weighting that fell short of the impact from stock selection miscues in the period. Conversely, our lower weighting in the lagging Health Care sector, along with a small assist from stock selection, was additive vis-à-vis the benchmark—just as in 2Q21. Successful stock picks in Information Technology, which outweighed the negative impact of our larger weighting, and having no exposure to lagging Utilities also helped relative results.

What’s your outlook for the Fund?

CR A few cyclical sectors began to lag the Russell 2000 in mid-May when the yield curve flattened with the decline in the 10-year Treasury yield. These short-term shifts have not altered our constructive stance on the Fund’s economically sensitive holdings, however. We’re still confident that cyclical small caps are poised for a strong run in the coming years. Our confidence is underscored by current expectations for strong nominal GDP growth in the U.S. this year and next coupled with an accommodative Fed and attractive relative valuations. Equally important, we remain excited about the opportunities in small caps, an asset class with a large number of diverse and interesting companies and evolving industries. We’ve recently been focusing even more than usual on identifying businesses that were able to use the difficulties created by the pandemic and ensuing recession to get stronger. We’ve been finding these kinds of businesses selling at what we think are attractive valuations largely in Industrials, Information Technology, and Financials. We believe that we’re embarking on the leg of the cycle when company results, rather than valuation expansion, typically begin to drive most of the stock price movement—and we think that’s an environment that suits our skill sets well.

Mr. Royce’s, McBoyle’s, and Palen’s thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

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I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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