Royce Total Return Fund
FUND PERFORMANCE
We were once again left with mixed feelings about the performance of Royce Total Return Fund. For the year-to-date period ended June 30, the Fund advanced a modest 0.7%, lagging its small-cap benchmark, the Russell 2000 Index, which gained 4.8% for the same period. The Fund trailed its benchmark during both the first quarter, when it was up 1.8% compared to 4.3%, and the second, when it slipped 1.0% versus a 0.4% gain for the smallcap index. This was all unquestionably disappointing, but not entirely unexpected in the context of the current small-cap market cycle. Year-to-date returns for the Russell 2000 were the result of what looked to us like a seriously disjointed small-cap marketplace. First-half performance for the index came overwhelmingly from the Health Care sector, led by biotech stocks. This sort of narrow, growth-driven environment is not conducive to strong relative results for a portfolio populated with dividend-paying small-caps chosen primarily for their sterling fundamentals, solid profitability, and attractive valuations. When lower overall levels of volatility are factored in, recent results become even easier to understand. Which is not to say that we are happy with recent relative performance, only that these results make sense considering the dynamics of the current small-cap market, one in which Total Return has achieved solid absolute returns even as it has trailed the Russell 2000. We have been anticipating a shift away from this environment and toward one in which interest rates are rising, overall equity returns are lower, and volatility is higher, which should benefit the sort of conservatively capitalized dividend payers that we prefer. We remain proud of the Fund’s longer-term relative advantages and its strong absolute performance. Total Return outperformed the Russell 2000 for the 15-, 20-year and since inception (Dec. 15, 1993) periods ended June 30. The Fund’s average annual total return since inception was 11.0%.
What worked … and what didn't
Portfolio net gains and losses at the level of sector, industry and position tended to be moderate. The Fund paid a relatively steep price for its underweight in Health Care and, to a lesser degree, Information Technology. The first of these sectors led the equity markets as a whole, including small-cap. Biotech companies, which do not fit the Fund’s valuation or fundamental criteria, were by far the dominant industry. Financials, the Fund’s largest sector at the end of the first half, was also its top contributor. Three of the portfolio’s best four performing industry groups came from the sector — capital markets, insurance (its two largest) and banks. The first of these groups had an appreciably larger net gain than its counterparts, driven by strong results for two asset management businesses we think very highly of. Value Partners (Trades, Portfolio) Group is a Hong Kong-based firm that has focused on Asian markets for more than two decades. Increased performance and management fees helped to boost net profits. When the Chinese equity markets plummeted in June, we were pleased that the firm’s stock held up well. The share price of AllianceBernstein Holding (AB, Financial) — Total Return’s second-largest position at the end of June — also cooled off a bit near the end of the first half but held on to most of its net gain from earlier in the year. Long-time holding and top-10 position ManpowerGroup (MAN, Financial) was the Fund’s top net gainer for the first half. The company has a global business providing staffing and other workforce solutions. Two consecutive quarters of better-than-expected earnings, fueled by an improved labor market, pushed up its shares. The Fund’s largest position at the end of June — and another long-term holding — was specialty insurer Markel Corporation (MKL, Financial). Robust underwriting and investment operations led to steady earnings improvement and a consistently rising share price in the first half. As for positions that detracted from performance, Tidewater (TDW, Financial) provides marine service vessels to offshore energy companies. Its stock fell with the decline in energy prices and bottomed out in April following a fiscal third-quarter loss reported in February that was nonetheless not as severe as most analysts had been expecting. We have been pleased with the way Tidewater has executed during a highly challenging period for energy companies. Balchem Corporation (BCPC, Financial) specializes in making performance ingredients for the food, feed, and medical sterilization industries. Its price fell in late June as insider sales seemed to shift Wall Street’s opinion. The Energy, Materials and Utilities sectors posted net losses in the first half while those that finished in the black included Health Care, Consumer Staples, Consumer Discretionary and Industrials.
Top contributors to performance:
- ManpowerGroup
- Value Partners (Trades, Portfolio) Group
- Markel Corporation
- AllianceBernstein Holding L.P.
- GameStop Corporation (GME, Financial)
Top detractors from performance:
- Tidewater
- Balchem Corporation
- Greif Cl. A (GEF, Financial)
- E-L Financial (ELF, Financial)
- Vishay Intertechnology (VSH, Financial)
Current positioning and outlook
We continue to believe consistent dividend-paying small-cap companies can offer long-term advantages. At the end of the first half, the Fund’s sector weightings remained close to the range they have been in since the end of 2013. Our belief that we will see both continued economic expansion in the U.S. and an earnings-led rally for small-caps has led us over the past few years to favor more cyclical sectors such as Industrials, Consumer Discretionary and Materials. We were overweight in the first and third of these sectors at the end of June while also being overweight in Financials.
