Royce Opportunity Fund
FUND PERFORMANCE
Royce Opportunity Fund finished the year-to-date period ended June 30 with a gain of 0.7% versus an increase of 4.8% for its small-cap benchmark, the Russell 2000, for the same period.
The Fund first lost a chunk of ground to its benchmark during a bearish January, which hurt its early results. For the first quarter, Opportunity rose 1.1% compared to 4.3% for the Russell 2000. The second quarter saw another relative disadvantage, made worse by a very difficult June. On the second-to-last day of the month, news of the Greek default wreaked havoc on stock prices, and the Fund lost more than the Russell 2000. For the second quarter the Fund was down 0.4% while the small-cap index was up 0.4%. 2015’s firsthalf results notwithstanding, Opportunity maintained longer-term advantages over its benchmark. The Fund outpaced the Russell 2000 for the 10-, 15-year and since inception (Nov. 19, 1996) periods ended June 30. ROF’s average annual total return since inception was 12.7%. We take great pride in the Fund’s nearly two decades of strong long-term results.
What worked … and what didn't
Typically a strong performer in any bull market, Opportunity was hurt by the very narrow leadership within small cap over the last 12 months, a period in which biotech dominated returns for both the asset class and domestic equities as a whole. Hewing to the time-tested idea that broad diversity across industries and positions works best in the Fund, we were not too surprised by the portfolio’s first-half performance results. Our theme-driven, opportunistic value approach emphasizes very inexpensive stocks — as determined by low price-to-book and price-to-sales ratios — so we had no exposure to biotech or pharmaceuticals companies, which sport very rich valuations. This lack of exposure was the most significant factor in the Fund’s relative disadvantage in the semiannual period. So while Health Care finished the first half as the portfolio’s second-best contributing sector, its net gains were modest on an absolute level as well as compared to the benchmark and came mostly from companies in the life sciences tools and services group and health care equipment and supplies industry.
The Fund’s largest sector at the end of June was Information Technology. The size and diversity of this sector have for many years made it a regular source of investment opportunity for us. In the first half, its diversity could perhaps best be seen by the starkly different results for its industry groups within the portfolio (this could also be seen within the Russell 2000). Two of the Fund’s best-performing industries came from IT. Net gains for the semiconductors and semiconductor equipment group were strong enough to not only lead on an industry basis by a wide margin but were also appreciably higher than those for each of the Fund’s equity sectors. Conversely, three of the portfolio’s four largest-detracting industry groups also came from Information Technology — electronic equipment, instruments and components stocks (where net losses nearly rivaled the gains achieved by the semiconductor industry), IT services companies and the technology hardware storage and peripherals group.
Within Materials, the metals & mining group was home to the Fund’s biggest contributor and two of its most significant detractors. Fading aluminum prices stymied results for both Century Aluminum (CENX, Financial) and Noranda Aluminum Holding Corporation (NOR, Financial), though the latter company put shares on sale at a sizable discount prior to the commodity price decline, exacerbating its losses. Our confidence in an eventual rebound for industrial metals led us to increase our stake in both companies. RTI International Metals (RTI, Financial) specializes in titanium and other metals and sells primarily to the aerospace industry. Its shares shot up quickly in March when Alcoa (AA) announced an agreement to buy the company.
TRC Companies (TRR, Financial) is an engineering, environmental consulting and construction management firm. In spite of having virtually no Wall Street coverage, its improved earnings and expanding margins drew enough attention to its stock for it to advance significantly in the first half. We trimmed our position as its price rose. Interface (TILE, Financial) produces modular carpet tiles for a variety of industries. It is one of many companies we own in the nonresidential construction space, though it is also involved in the residential area running Flor, which sells carpet squares. Improved results in its corporate, hospitality, and retail flooring businesses, as well as its status as an environmentally conscious business, keyed an increase for its shares.
Top contributors to performance
- RTI International Metals
- TRC Companies
- Interface
- EarthLink Holdings (ELNK, Financial)
- NeoPhotonics Corporation (NPTN, Financial)
Top detractors from performance
- Century Aluminum
- Silicon Graphics International (SGI, Financial)
- McClatchy Company (The) (MNI, Financial)
- Noranda Aluminum Holding Corporation
Current positioning and outlook
We have been pleased by the number of bargains that we have found within several industries, including a number of positions in Information Technology, Industrials, and Consumer Discretionary. At the end of June we were substantially overweight in the first two sectors and overweight in the third. Many holdings that we built or first began to buy in the first half fall under our Turnarounds investment theme, an area that we think should generally do well as the pace of economic growth picks up, as we suspect it will. Nonresidential construction remains an area of focus, as the industry is beginning to enjoy what we anticipate should be a long-term recovery.
