Royce Value Fund’s Investment Strategy via Royce Funds

Portfolio Manager Jay Kaplan and Co-Chief Investment Officer Francis Gannon detail how Jay has been positioning Royce Value Fund’s portfolio, why Jay has been reducing the number of names, where he is currently finding bargains, and more.

Francis Gannon: Let’s talk about the Value Fund. Performance has been quite strong over the past year. Some of the biggest changes have been your taking the Consumer Discretionary area up in the portfolio and bringing the Materials area down in the portfolio. Can you talk about that and your decisions there?

Jay Kaplan: Well, the Materials area was never really a business that I’d fallen in love with, so we exited some of those. And then we went to look for what was on sale in the market, where’s the opportunity, and what we found was that the consumer sector was then, and even a year later still is, to a great degree, completely discounted by the market.

The market believes that people will never shop again. Totally not true. Christmas season of 2013 wasn’t great, and that’s okay. I mean the companies that we’re invested in, even though Christmas was tough, they were all very profitable, had nice returns in their businesses, and, again, once things get better and earnings go up, they’ll get higher valuations.

Francis: Is there a return profile you look for consistently?

Jay: We’re looking for double-digit returns on capital. We’re looking for high single-digit returns on assets, and we’re looking for companies that are self-funding, companies that generate free cash flow, companies that, absent large projects or deals, don’t need to access the capital markets. So when there’s a capital market event like there was in late ’08/early ’09, our companies aren’t in danger of running out of money.

Francis: One of the other things you’ve done in the Fund over the past year is cut the number of names. Take us through your thought process there.

Jay: I’m not sure it was an overt thought process to take the number of names down. After I sold some of the names that I didn’t like and added some names that I liked, given where the market was, given the valuation of the market, there weren’t a lot of bargains.

We try to be thoughtful about where we put investors’ money and try to do things that we think are going to be smart, and we don’t invest for the sake of investing. So the number of interesting ideas, it’s fewer today, and that’s okay.

So we’re running a little more concentrated than we would normally be. When market conditions allow, and when there are more things to buy, we’ll probably take the number of names back up again, but for now it’s served us okay.

Francis: And tell us about the positioning of the Fund.

Jay: It’s pretty heavily consumer. There’s a pretty good energy bet, and there’s a pretty good slug of technology stocks as well. Some people think that value investors don’t do technology. Technology comes in a lot of flavors, so we do a lot of that as well.

There are a lot of 3% positions in the Fund, so it’s kind of concentrated for Royce. We have somewhere between 50 and 60 names in the current environment.

Francis: We spent a little time on Consumer Discretionary. Talk about some of the industry themes you might be seeing in technology.

Jay: It’s all over the place. There’s technology semiconductor capital equipment.  There are services. We own a call center business. It’s not a high-tech company, but it’s low technology. We do companies that are in the military supply business and military IT. So it’s defense oriented, but it also has a technology component. So it’s more than just chips, bits, and bytes.

Francis: How should investors think about the Value Fund?

Jay: Well, I think the first thing to think about is it’s a three- to five-year endeavor for anyone who decides to join us in the Royce Value Fund. I’m a big shareholder of the Value Fund and everything we do is very long term. And they should think about it as a portfolio of quality businesses, and they should think of themselves as business owners.

Royce Value Fund [RYVFX]

Average Annual Total Returns as of Quarter-End 3/31/14 (%)

QTR YTD 1 YR 3 YR 5 YR 10 YR 15 YR 20 YR SINCE INCEPT. DATE
Value 1.04 1.04 25.22 5.97 20.33 10.18 N/A N/A 11.61 6/14/2001
Russell 2000 1.12 1.12 24.90 13.18 24.31 8.53 8.91 9.48 8.39 N/A
Annual Operating Expenses: 1.48%