FUND PERFORMANCE
Royce Small-Cap Leaders Fund (formerly Royce 100 Fund) was down 12.5% in 2015 versus a loss of 4.4% for its small-cap benchmark, the Russell 2000 Index, for the same period. For the year-to-date period ended June 30, 2015, the Fund fell 0.1% while its benchmark gained 4.8%. A far-reaching correction hit stocks in the third quarter, when the Fund fell 13.7% versus a decline of 11.9% for the small-cap index. During the fourth quarter’s recovery, the portfolio increased 1.5% versus a gain of 3.6% for the Russell 2000.
The year ended in much the same way it began—with narrow market leadership from mostly growth-oriented stocks, particularly in Health Care (though the fourth quarter also saw strength for more growth-oriented tech businesses). The lack of breadth was an issue, with one data point, we think, being especially telling: In 2015 the Russell 2000 lost 10.1% on an equal-weighted basis. In the year’s most noticeable exception to this pattern of narrow leadership—the third-quarter correction—small-cap value enjoyed a brief period of leadership. This short-lived phase was nonetheless encouraging to us—we suspect that contracting access to credit, lower equity returns, and reversion to the mean should all help to boost active approaches. We feel confident that our emphasis on what we believe are leading small-cap companies that have strong business models and competitive positions, superior balance sheets, and attractive prospects for growth can be successful. The Fund’s average annual total return for the since inception (6/30/03) period ended December 31, 2015 was 8.5%.
WHAT WORKED… AND WHAT DIDN’T
Five of the Fund’s eight equity sectors finished the year in negative territory, which compared favorably to the benchmark, where eight of 10 sectors declined in 2015. Consumer Discretionary, Financials, Industrials, Energy, and Materials all detracted from performance, with the first four groups posting the largest net losses. At the industry level, three groups were notably negative—energy equipment & services, capital markets, and specialty retail. On a position level, however, a chemical company was the Fund’s loss leader. Minerals Technologies (MTX, Financial) provides minerals-based value-added products. Overall revenue growth has slowed in part due to tepid demand in steel and paper production— two of its key end markets. The decelerating pace of industrial growth in China also hurt during the second half of 2015 as that country has become a market of growing importance. Consistent with its history, management has maintained solid profit margins in the face of weaker sales. The company also authorized a share repurchase program in September, signaling a long-term confidence in the business which we share.
The Buckle (BKL, Financial) is a mall-based casual clothing retailer whose business has been challenged by several factors, including the lack of compelling new jeans styles for women, some excess inventory, the unseasonably warm fall and winter, lower mall traffic, and rampant discounting, especially in the all-important fourth quarter. We like its long history of successful execution and shareholder-friendly capital allocations, such as the $1 per share special dividend the company paid in December in addition to its regular quarterly payout. From the Energy sector, Unit Corporation (UNT, Financial) is involved in several businesses, including oil and natural gas exploration and contract drilling services. We sold our shares in the third quarter due to our higher conviction in other energy services names that we think are better positioned to generate high returns on invested capital over the long run.
The Fund’s top contributor was John Bean Technologies (JBT, Financial), which sidestepped the travails that many other industrial companies faced in 2015. The company manufacturers and services food processing and airport transportation equipment. A new CEO came on board in September 2013. He strengthened the management team which in turn has executed superbly on revenue growth and profit improvements. We reduced our position as its shares rose but held enough to make it a top-20 holding at year-end. We like its enviable market position, favorable long-term growth trends, attractive acquisition opportunities, and further room for margin expansion.
On a relative basis, the Fund was hurt most by Financials— specifically our underweight in banks and overweight in capital markets—as well as an underweight in Health Care and ineffective stock picking in Consumer Discretionary. Conversely, stock picking was a relative strength in Consumer Staples.
Top Contributors to Performance For 2015 (%)
- John Bean Technologies 1.12%
- ManpowerGroup 0.60%
- Orbotech 0.49%
- Sykes Enterprises 0.42%
- j2 Global 0.38%
Top Detractors from Performance For 2015 (%)
- Minerals Technologies -1.14%
- Buckle (The) -1.08%
- Unit Corporation -0.93%
- Saia -0.90%
- Veeco Instruments -0.78%
CURRENT POSITIONING AND OUTLOOK
We expect reversals in a number of trends that should help benefit a number of 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 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.
