Royce Total Return Fund Manager Commentary
Based on the calendar-year performance of Royce Total Return Fund, certain small-cap stock investors chose other opportunities than those present in moderate dividend-paying companies. The Fund, which invests primarily in dividend paying small-cap companies, gained 32.8% in 2013, lagging its small-cap benchmark, the Russell 2000 Index, which was up 38.8% for the same period.
We were satisfied with the Fund’s results on an absolute basis. While we would have welcomed a stronger relative showing, 2013 performance remained consistent with how Total Return has performed in other dynamic bull phases. In addition, non-dividend-paying companies within the Russell 2000 once again outperformed those that do, as was the case in 2011 and 2012. After beating the Russell 2000 in the second half of 2012 (+9.8% versus +7.2%), the Fund slipped behind the small-cap index in the first quarter of 2013 as faster-growing, higher-leveraged issues once more led the small-cap run. For the opening quarter, the Fund was up 10.6%—a fine absolute result—compared to 12.4% for the Russell 2000.
The second quarter saw more volatility, with April mostly bearish and June fairly unsettled; in the latter case the cause was taper talk on the part of the Fed and rapidly rising interest rates. For the quarter as a whole, the Fund was up 2.0% compared to a 3.1% gain for the Russell 2000. The markets settled down and share prices began moving up again early in July. While generally not as robust as the first quarter, the third was nonetheless strong. Total Return gained 8.2% versus a 10.2% increase for the small-cap index from the beginning of July through the end of September. The fast pace relented a bit in the fourth quarter—mid-December was particularly rocky—though small-cap results remained firmly in the black. The Fund was essentially even with the Russell 2000 in this period, both climbing 8.7%.
While relative results over the last three calendar years have worn away Total Return’s performance edge during certain intermediate-term and market cycle periods, results remained strong over longer-term spans. The Fund beat the Russell 2000 for the 10-, 15-, 20-year, and since inception (12/15/93) periods ended December 31, 2013. Total Return’s average annual total return since inception was 11.7%. We are quite proud of the Fund’s two full decades of performance.
Small-cap stocks are an asset class in which dividends are often ignored and volatility can be high, yet we see dividends as one of the strongest links on a company’s capital allocation chain and a key element of strong, long-term total returns. It seems doubtful to us that the market can sustain its currently fervid pace, so we see the potential attraction in the kinds of conservatively capitalized, dividend-paying small-cap companies that we seek for the Fund’s portfolio. Investors began to pay more attention to business fundamentals in the last six months of 2012, and while the flirtation was all too brief, we see the possibility of greater commitment in a more challenging market, especially one with rising interest rates, which is likely to provide renewed interest in businesses with strong balance sheets. We are very comfortable with the way the portfolio is positioned as we look forward.
The top sectors for the calendar year were Financials, which led by a wide margin, and Industrials, which also posted impressive net gains. Other notable contributions came from the Consumer Discretionary and Energy sectors. Ten of the Fund’s 11 equity sectors finished the year in the black, an unsurprising development in such a vigorously bullish year. At the industry level, insurance companies and capital markets stocks, both from the Financials sector, were the standouts. In the insurance industry, E-L Financial, an investment and insurance holding company based in Toronto, was the top contributor. We like its core business and dividend and were pleased to see other investors attracted to the the Fund’s largest holding at year-end.
Nu Skin Enterprises develops and distributes personal care skin products worldwide. After enjoying a strong first half, its share price gained additional momentum in the year’s last six months. In October, the company announced stronger-than-anticipated third-quarter earnings and raised its full-year guidance for 2013, driven by the success of a limited-time offer for its new weight management system. Towers Watson & Company provides human resource, financial consulting, and other related services. Its price rose more or less steadily throughout the year. In May the firm’s management raised adjusted EPS (earnings per share) guidance for fiscal 2013 while the stock also gained from the opening of Obamacare insurance exchanges in October. It then raised its dividend in November. We have liked its core business and steady earnings for several years having first bought shares in the portfolio in 2003.
We added to our stake in clothing retailer American Eagle Outfitters because we think its niche in teen clothing is strong enough to withstand increased competition and recent declines in sales. Nam Tai Electronics makes components including LCD (liquid crystal display) modules and panels. Slumping demand led the company to ponder a halt in production, which sparked a significant sell-off in late April. We significantly reduced our position between May and July.
Average Annual Total Returns as of Quarter-End 12/31/13 (%)
Annual Operating Expenses: 1.14%
Current month-end performance may be obtained from our Prices and Performance page.
All performance information in this Report reflects past performance, is presented on a total return basis, reflects the reinvestment of distributions, and does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, so that shares may be worth more or less than their original cost when redeemed. Shares redeemed within 180 days of purchase may be subject to a 1% redemption fee payable to the Fund, which is not reflected in the performance shown above; if it were, performance would be lower. Current monthend performance may be higher or lower than performance quoted and may be obtained here. All performance and risk information reflects results of the Investment Class (its oldest class). Operating expenses reflect the Fund’s total annual operating expenses for the Investment Class as of the Fund’s most current prospectus and include management fees, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies. Shares of RTR’s Service, Consultant, R, and K Classes bear an annual distribution expense that is not borne by the Investment Class. Regarding the two “Good Ideas” tables shown above, the sum of all contributors to, and all detractors from, performance for all securities in the portfolio would approximate the Fund’s performance for 2013.
The thoughts expressed in this piece concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at December 31, 2013, and, of course, historical market trends are not necessarily indicative of future market movements. Statements regarding the future prospects