Royce Investment Partners: Sma – GuruFocus.com
How did the Small-Cap Premier Quality strategy perform in 2Q22 and the first half of 2022?
Laurent Romeo The mutual fund we manage under this strategy, Royce Premier Fund, fell 12.8% in 2Q22, maintaining a significantly higher value than its benchmark, the Russell 2000 Index, which fell 17.2%. Although negative performance is never our goal, we were pleased that our high quality small cap portfolio lost less than our benchmark.
Steven Mc Boyle A similar trend held for the year-to-date period ended 6/30/22. Premier fell 19.2%, which is hardly a desirable absolute return. However, the Fund outperformed the Russell 2000, which lost 23.4% in the index’s worst performance ever in the first half by a wide margin. We were pleased that these better market results allowed the Fund to maintain its long-term advantages over the Russell 2000. Premier beat the small cap index for stocks at one, three, five, 15, 20 and 25, 30 years and since inception (12/31/91) periods ended 06/30/22. The Fund’s average annual total return since inception has been 10.9%. We are very proud of the Fund’s long-term performance record.
Which sectors had the most effect on 2Q22 performance?
L/R With such a broad-based decline in small caps seen during the quarter, it’s probably unsurprising that each of the 10 equity sectors in which Premier held investments had a negative impact on performance. Our two largest companies, Information Technology and Industrials, detracted by far the most from performance, followed by Financials. The smallest declines came from consumer staples, communication services and health care.
What has had the greatest impact among the Fund’s industry groups?
SM At the industry level, two information technology groups had the first and third largest negative impact: electronic equipment, instruments and components and semiconductors and semiconductor equipment. Capital markets, finance, finished second. Only two industries ended the second quarter in the dark: automotive components (Consumer Discretionary) and business services and supplies (Industrials). Backing up Lauren’s earlier observation, this gives you an idea of how tough the quarter was.
Still, the news was more encouraging relative to the Russell 2000: what were some of the details of Premier’s relative outperformance in 2Q22?
SM Our advantage over the benchmark came entirely from stock selection in the second quarter. It was particularly strong in industrials, consumer discretionary and materials, the sectors which had the most significant positive impact relative to the Russell 2000. Conversely, stock selection and our lower weighting hurt consumer staples, as did our lack of exposure to utilities and energy.
Looking at the first half of the calendar year, which sectors had the biggest impact on performance?
L/R It’s a very similar story, given that it was the worst first half for small caps in over 40 years. As investors might expect, all nine sectors in the portfolio detracted from performance from the start of the year through the end of June. It was truly a “nowhere to run, nowhere to hide” first half for small caps. The Information Technology, Industrials and Consumer Discretionary sectors had the largest negative effect, while the weakest came from Communication Services, Real Estate and Consumer Staples.
What went wrong industry-wise in the first half of 2022 and which areas contributed?
SM Equipment, instruments and electronic components, resulting from information technologies; capital markets, which are part of financial services; and machinery, in the industrials sector, has been the biggest detractor in the year-to-date period, while insurance, which is also in financials; metals and mining in materials; and marine, another area of industries, were major contributors.
Which position detracted the most from performance for the year-to-date period ending 6/30/22?
SM It would be MKS instruments (MKSI, Financial), which manufactures equipment used to control and analyze gases in the semiconductor manufacturing process. Its shares fell more than 30% in the second quarter. The SOX (Philadelphia Semiconductor Index) fell 25.5%, so MKS’ decline partly reflects the selloff in semiconductor capital goods stocks, which is rooted in evidence of more and more as inflation began to dampen spending on discretionary items, including smartphones and other consumer electronics. Trade press sources also reported that major foundries were beginning to push back equipment orders as inventories of certain chip categories began to normalize. More specifically for MKS, the company has faced continued delays in obtaining Chinese regulator approval for its proposed acquisition of Atotech, a global leader in electroplating chemicals used in manufacturing processes. chips and printed circuit boards. Atotech would increase MKSI’s consumables revenue stream by 40% and reduce the overall cyclicality of its business. Despite the recent pullback and increasing short-term cyclical headwinds – which include a possible digestion phase for semiconductor capital goods – we believe that MKS’ leadership in critical semiconductor capital equipment components -conductors and its efforts to replicate its successful strategies in adjacent markets positions the company to benefit from long-term secular growth drivers, such as the proliferation of semiconductors, the increasing complexity of chip structure and packaging for new generation and the increased miniaturization of microelectronics.
What was the most contributing position in the portfolio in 2022?
L/R Our first contributor was Meridian Bioscience (LIVE, Financial), a profitable healthcare company that manufactures consumable reagents used in in vitro diagnostic (IVD) testing and develops IVD tests and instruments. The company has a particularly strong niche position in various gastrointestinal diseases. After a gain of 27% in 1Q22 thanks to a further acceleration in the growth of its volume of diagnostic tests and market share gains linked to new products in reagents, its stock rose by 17% in 2Q22 despite very little company-specific public news. The reason for its rise was revealed on July 7, when Meridian announced an agreement to acquire SD Biosensor, a South Korean healthcare company, and its private equity partner for $34 in cash. Although this is a minimal premium to the current price, it was 32% above Meridian’s share price when the initial offer was made privately a few months earlier.
How did the portfolio compare to the Russell 2000 in the first half of 2022?
SM As was the case in the second quarter, our relative advantage came exclusively from stock selection year-to-date, with stock selection particularly strong in the healthcare, industrials and consumer discretionary sectors. , which had the most significant positive impact. compared to the reference. Conversely, Energy and Utilities again detracted due to our lack of exposure, while Consumer Staples detracted from relative results year-to-date due to both stock selection and our underweight in the sector.
What are your prospects for the Fund?
L/R It appears that near-term market sentiment will continue to be dominated by fear and uncertainty in the face of multiple macro trends – and some offsetting trends – which have varying implications for the stock market – particularly inflation, rising rates and a slowing economy. We believe these conditions will continue to favor small cap quality as investors seek refuge in companies with sustainable business models, strong balance sheets and consistent free cash flow generation. The financial flexibility to self-fund growth regardless of short-term cyclical trends allows quality businesses to capitalize on secular opportunities that are tailwinds to growth for many of our businesses, for example, those involved in automation, digital transformation, infrastructure spending and semiconductor capital. intensity. Although our holdings are not immune to recessions, their strong financial characteristics should give them the ability to not only survive difficult macroeconomic conditions, but also emerge stronger when conditions improve. They should be able to take market share from weaker and more indebted competitors and/or acquire it at attractive multiples. We have seen a similar dynamic during the global financial crisis and the recent pandemic. The case for quality within small caps also has a valuation on its side. At the end of June, small caps were at their lowest relative valuation against large caps in over 20 years. Within small caps, quality, as measured by high ROIC (return on invested capital), continues to trade at a discount to profitable small caps and the Russell 2000 as a whole. We believe this combination of sustainable business models and attractive valuations makes the portfolio a potentially attractive way to gain strong relative downside protection while generating attractive long-term returns on an absolute and relative basis.
Ms. Romeo’s and Mr. McBoyle’s thoughts and opinions regarding the stock market are their own and, of course, there can be no assurance as to future market movements. There can be no assurance that past performance trends as described above will continue in the future.
The performance data and trends described in this presentation are presented for illustrative purposes only. Past performance is not indicative of future results. Historical market trends are not necessarily indicative of future market movements.