Total Return: Managing Risk By Investing In Dividend-Paying Stocks by Royce Funds

Small-cap is an asset class that has historically been associated with increased volatility. We have always believed that dividends, plentiful in the small-cap space, can help mitigate some of that risk. But what are we looking for in the dividend-paying companies in which we invest? Portfolio Manager Jay Kaplan and Co-CIO Francis Gannon discuss.

See the video here.

Total Return: Managing Risk By Investing In Dividend-Paying Stocks

Francis Gannon: How should investors think about Royce Total Return Fund?

Jay Kaplan: The name is really important. The Total Return Fund really is about total return—it seeks to provide a lower-risk strategy within the small-cap space.

We’re looking to find really high quality, mostly dividend-paying companies that can also grow over time. We think that when you get some cash back along the way, it helps to take out some of the volatility that’s generally associated with small-cap investing.

Now there’s a tradeoff, of course. In really big bull markets you would expect that the Fund might lag a little bit. In bear markets you would expect that the Fund would do less bad than the market overall. And all of that would be in the context of lower volatility and really good risk-adjusted returns.

So if someone goes onto our website and looks at some of the numbers and some of the math, you would find out that on a risk-adjusted basis we’ve been able to deliver good risk-adjusted returns.

So for the investor that wants to participate in small-caps but wants to take some of the volatility away, Total Return’s a very interesting proposition.

Francis: Obviously very topical this year is interest rates. How would higher rates affect dividend-paying smaller companies?

Jay: There’d probably be a little pressure on some dividend-paying smaller companies if rates went up, but there are some different classes of dividend-paying companies, and maybe it’s a good time to explain a little bit more about how we approach Royce Total Return Fund.

Many funds that talk about dividends are out trying to chase the highest yields they can find. We don’t do that. If we were going to do that, our portfolio would be loaded with REITs, MLPs, and Utilities. And, in fact, it’s not—mostly because those companies are highly leveraged and we try not to invest in highly levered companies.

For us, dividends are important. But it’s not high dividends—it’s the ability to pay dividends, the ability to pay dividends through cash flow, the ability sometimes to grow dividends over time. But, most importantly, it’s the ability for the companies to grow their operating income and compound wealth that way.

So relative to other income-producing equity vehicles, we think Total Return Fund stands a pretty good chance of doing OK when rates finally go up.

Francis: How does that help you manage risk in today’s environment?

Jay: I think it helps in a really good way. I think, since we are poised for higher rates, we are ready for the big dividend payers, frankly, to go down. We’re not going to face that to the same degree. We’re interested in owning businesses rather than stocks, not clipping coupons, and compounding wealth over time.

Royce Total Return Fund [RYTRX]

Average Annual Total Returns as of Quarter-End 3/31/15 (%)

Total Return 1.77 1.77 2.57 12.90 12.12 7.80 10.17 11.32 11.16 12/15/93
Russell 2000 4.32 4.32 8.21 16.27 14.57 8.82 7.19 9.62 9.33 N/A
Annual Operating Expenses: 1.19%