Royce Micro-Cap Fund
FUND PERFORMANCE
Royce Micro-Cap Fund was down 1.4% for the year-to-date period ended June 30, 2015, lagging both its benchmark, the Russell Microcap Index, and the smallcap Russell 2000 Index, which advanced 6.0% and 4.8%, respectively, for the same period. The Fund was again challenged by its lack of participation in a bullish period for both micro-cap and small-cap stocks. However, it should be noted that returns within each asset class were narrower than yearto-date results for the respective indexes might suggest, with biotech remaining a primary driver of returns during the first half of 2015. In the first quarter, Royce Micro-Cap fell 0.3% as a bearish January outdid positive returns in both February and March.
By contrast, the Russell Microcap gained 3.1% for the first quarter while the Russell 2000 rose 4.3% for the same period. The Fund’s performance worsened in the second quarter, especially hurt by the wave of volatility that the Greek default sent through the markets at the end of June. The Fund lost 1.1% for the second quarter while the micro-cap index and small-cap index increased 2.8% and 0.4%, respectively. Longer-term relative results were better. Royce MicroCap outperformed the Russell Microcap for the 15-year period ended June 30, 2015 and beat the Russell 2000 for the 15-, 20-year, and since inception (Dec. 31, 1991) periods ended June 30. (Data for the Russell Microcap only goes back to June 30, 2000.) The Fund’s average annual total return since inception was 11.6%. We are very proud of the Fund’s long-term performance history.
What worked … and what didn't
Health Care was something of a double-edged sword for the portfolio. The sector comfortably led both the Fund and the Russell Microcap in the first half. Returns for the index, however, were dominated by biotech stocks. Most of these businesses lack either the conservative capitalization or earnings profile that we look for when building our portfolio. The Fund was therefore significantly underweight in Health Care during the first half and had little exposure to biotech. Net gains came primarily from companies in the health care equipment & supplies and the health care providers & services industries. So while the sector was by far the portfolio’s top contributor in the first half, its net gains were not as vigorous as were those for the sector within the Russell Microcap.
Firearms maker Smith & Wesson Holding Corporation (SWHC, Financial) was the Fund’s best-performing position in the first half. The company continued to gain market share while recent sizable investments in R&D have been driving significant product innovation. Its shares also benefited from effective cash flow allocation into strategic acquisitions that are providing vertical manufacturing integration as well as adjacent product offerings. The stock of financial services business INTL FCStone began to climb in February. It has a growing niche in automated international currency settlements and was thus rewarded in an increasingly volatile global currency market. Of the Fund’s five sectors that finished the semiannual period in the red, only Energy and Materials posted sizable net losses. Gulf Island Fabrication fabricates offshore drilling and production platforms, as well as other steel structures for the oil and gas and marine industries. Recent results have been hurt by the decline in commodity prices, which has led to a slowdown in its business. Still, we like how this low-debt, assetrich firm has been executing through a highly challenging phase for its industry. We held a good-sized position at the end of June. Exposure to the energy industry also played a role in dismal results for Global Power Equipment Group (GLPW, Financial), which makes gas turbine generation equipment. Also contributing to the decline in its stock price were the resignation of its CEO in March and the announcement in May that it would need to restate financial statements. While this was a clearly disappointing turn of events, we chose to hold our position, at least for the short term. The company’s highly attractive valuation and strong balance sheet offered enough interest for us to allow the dust to settle around a business that we like for the long term.
Two for-profit education businesses were also among the portfolio’s top detractors in the first half — American Public Education (APEI, Financial) and Capella Education (CPLA, Financial). The industry has been under fire of late and is enduring a round of new, more stringent federal regulations. We think each of these companies has the management talent and fundamental strength to survive these challenges.
Top contributors to performance year-to-date through June 30
- Smith & Wesson Holding Corporation
- INTL FCStone (INTL, Financial)
- LSI Industries (LYTS, Financial)
- Culp Inc. (CFI, Financial)
- Ennis (EBF, Financial)
Top detractors from performance year-to-date through June 30
- Gulf Island Fabrication (GIFI, Financial)
- American Public Education
- Global Power Equipment Group
- Capella Education
- Graham Corporation (GHM, Financial)
Current positioning and outlook
Sector weightings at the end of June were relatively unchanged from where they have stood over the last 18-24 months. This is due to our ongoing preference for more economically sensitive sectors, such as the Fund’s three largest at the end of the period—Industrials, Information Technology, and Consumer Discretionary. We maintain the belief that many portfolio holdings in these (and other) sectors should benefit from a faster-growing economy that also could reward disciplined approaches that focus on fundamentals. So while the Fund’s recent performances have fallen below our expectations, we remain confident about its prospects going forward. We are also pleased to announce that on May 1, Royce veteran Jim Stoeffel joined Jenifer Taylor as the Fund’s co-portfolio manager. Jen has been involved in the Fund’s management for more than 11 years while Jim joined Royce in 2007 as portfolio manager.
