FUND PERFORMANCE
Royce Dividend Value Fund fell 5.7% in 2015, underperforming its small-cap benchmark, the Russell 2000 Index, which was down 4.4% for the same period. The Fund advanced 2.6% for the year-to-date period ended June 30, 2015 compared to a 4.8% gain for the smallcap index. During most of the first half, small-cap market leadership was tightly clustered around biotech and pharmaceuticals companies, leaving behind the kind of steadily profitable, conservatively capitalized small- and mid-cap dividend-payers that we prefer. This began to shift somewhat in the second quarter, when the Fund outpaced the Russell 2000, before it reversed even more dramatically in the third quarter’s correction when Dividend Value was down 10.2% compared to a decline of 11.9% for the benchmark. When small-caps rebounded in the fourth quarter, however, sentiment swung back to growth, primarily to Health Care and more growth-oriented technology. The Fund gained 2.4% for the fourth quarter versus a 3.6% increase for the index.
It was undoubtedly a difficult year. Taking great pride in the Fund’s long history of both low volatility and sterling down market returns, we found the year’s results particularly tough to digest. Yet the context is critical. First, 2015 was a more difficult year for small-caps than the benchmark’s return might show—on an equal-weighted basis, the Russell 2000 was down 10.1%. More important, the Fund trailed its benchmark when returns were positive and outpaced it when small-caps reversed—consistent with its history. For example, from the 2015 small-cap high on June 23 through year-end, the Fund lost 10.6% versus a slide of 11.6% for the Russell 2000. Dividend Value outperformed the Russell 2000 for the 10-year and since inception (5/3/04) periods ended December 31, 2015.
WHAT WORKED… AND WHAT DIDN’T
Six of the Fund’s 10 equity sectors finished the year in the red. Financials, Consumer Discretionary, Materials, and Energy detracted most. At the industry level, four groups posted meaningful net losses—capital markets, specialty retail, metals & mining, and energy equipment & services. It did not help our relative performance that we had much greater exposure to each of these groups than could be found in the Russell 2000. Health Care was the portfolio’s top contributor in 2015, but the positive effects of our stock picking in the pharmaceuticals industry were outweighed by our significant underweight in the sector as a whole versus the benchmark. Consumer Staples, on the other hand, contributed on both an absolute and relative basis, attributable mostly to terrific results for Hormel Foods, the portfolio’s top contributor in 2015. The company manufactures and markets consumer-branded meat and food products under a variety of branded names. We liked its low debt and strong brands and were pleased to see robust earnings growth attract investors to its stock. It was a top-10 position at the end of 2015. From the Industrials sector, John Bean Technologies was also another top-10 holding and contributor. It operates two divergent businesses—food-processing equipment, which has driven its impressive run of revenue and earnings growth, and airport operations equipment.
Two companies in the metals & mining group posted the Fund’s largest net losses at the position level in 2015. Allegheny Technologies (ATI, Financial) produces specialty materials, including titanium, titanium alloys, and nickel-based alloys. Losses have been driven by weakness in the energy market and increased competition in the firm’s flat-rolled products segment. Slackening demand for its stainless and some electrical steel products led the firm to slash its dividend and shutter some operations in Pennsylvania during December. Confident in a recovery for industrial activity, we held shares at year-end. Long-time holding Carpenter Technology (CRS, Financial) makes specialty alloys and performance engineered products. The first of these businesses was hurt by exposure to the energy markets in 2015 while the second did comparatively better. Both Carpenter and Allegheny could benefit from increased defense spending in 2016.
Financials and Information Technology detracted most on a relative basis in 2015. Our overweight in capital markets, an underweight in banks, and poor stock selection in the diversified financial services and thrifts & mortgage finance categories detracted most in Financials. For Information Technology, the issues were both an underweight and disappointing stock selection in the software industry. In contrast, stock selection in Industrials and Consumer Staples was strongest on a relative basis.
Top Contributors to Performance For 2015 (%)
- Hormel Foods - 0.43%
- John Bean Technologies - 0.39%
- SEI Investments - 0.32%
- Symetra Financial - 0.31%
- Diamond Hill Investment Group - 0.30%
Top Detractors from Performance For 2015 (%)
- Allegheny Technologies - 0.61%
- Carpenter Technology - 0.42%
- Coronation Fund Managers - 0.42%
- Buckle (The) - 0.39%
- Genworth MI Canada - 0.36%
CURRENT POSITIONING AND OUTLOOK
We expect reversals in a number of trends that should help benefit many portfolio holdings over the next few years. Our own research and regular meetings with confident management teams have made us comfortable with a contrarian, pro-cyclical bias for the portfolio. Moreover, we suspect that the protracted leadership of growth over value stocks is likely to reverse in 2016 and believe that companies with better balance sheets will do well in an environment of elevated corporate bond spreads. We also expect the combined effects of these reversals to put the market’s focus squarely on the attributes we emphasize, which we think are overdue for recovery.
