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Let Royce Do Your Small-Cap Digging

Posted: Nov 20, 2008 14:22 PM by Aaron Levitt

Filed Under: Futures

Tickers in this Article: AB, FUND, MVC, PAAS, RMT, RS, RVT, WEYS

In the world of investing, it sometimes pays to go with a specialist. By focusing funds on a single segment of the market, boutique firms can hone their stock-picking skills and analysis. Specialized firms offer regular Joes the chance to invest in hard-to-understand asset classes such as master limited partnerships or real estate investment trusts.

Currently, the case for small-cap stocks is compelling. The iShares Russell 2000 Index Fund (NYSEArca:IWM), which represents the small-cap universe, is currently down about 29% year-to-date. By finding an authority that concentrates on small company stocks, a manager can use his or her expertise to cherry-pick the best securities for investors' portfolios.

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Enter Royce Associates
In 1972, Charles Royce pretty much invented small-cap investing when he took over at the helm of Quest Advisory Corp. Since then, assets under management have bloomed to over $30 billion - $123 million of which is personally invested by Royce Associates employees and their families - and the company has become a wholly-owned subsidiary of Legg Mason. Fund managers who eat their own cooking make for a very bullish sign.

Using a bottom-up value investing tilt, Royce operates 22 open mutual funds and two portfolios for the annuity market. Its closed-end offerings provide investors juicy opportunities. Here, long-term investors are given the chance to buy some quality assets at a discount. (Get acquainted with closed-end funds at Uncovering Closed-End Funds and Open Your Eyes to Closed-End Funds.)

Three Closed-End Jewels
Investors who want to take a chance on the smallest of the small can look toward the Royce Micro-Cap Trust (NYSE:RMT). The fund invests in companies with market capitalizations of less than $500 million. Due to the sector's size (an estimated 5,400 micro-cap companies exist) and limited Wall Street research, Royce believes it can find pricing inefficiencies and exploit them for long-term investors. (Learn more about thinking small at How to Evaluate a Micro-Cap Company.)

Currently, the fund holds 547 stocks and warrants. Top holdings include MVC Capital (NYSE:MVC) and shoemaker Weyco Group (Nasdaq:WEYS). With Charles Royce in charge, the fund has returned an annualized 9.73% of net asset value (NAV) since inception and is trading at an 18% discount to its NAV. The Micro-Cap Trust has a managed payout distribution plan of 9% and typically pays out around 30 cents per quarter. Fees and expenses for the closed-end fund run 1.56% per year.

The largest and most broadly diversified of Royce's closed-end funds is the Royce Value Trust (NYSE:RVT), which invests in companies below a $1.5 billion market cap ceiling using a value approach. The fund currently holds 645 micro-, small- and mid-cap stocks. Top holdings include AllianceBernstein (NYSE:AB) and Lincoln Electric (Nasdaq:LECO). The Royce Value Trust's top-10 holdings account for a little under 12% of the fund's assets, and the fund has an average weighted market cap of $967 million.

For over 20 years of operation, the Royce Value Trust has returned an annualized 9.8% of NAV. Based on Wednesday's closing, it trades at an 11.9% discount to net asset value. The fund also applies the same managed payout distribution plan as the Micro-Cap Trust and fees and expenses run an annual 1.38%

Of Royce's closed-end funds, Royce Focus Trust (Nasdaq:FUND) has the highest risk-to-reward ratio. The Royce Focus gives long-term investors a concentrated small-cap portfolio in order to enhance returns. It only counts 53 stocks and warrants among its holdings and fund manager W. Whitney George, using a value approach, selects stocks he thinks will outperform over a long time line. Current holdings include Pan American Silver (Nasdaq:PAAS) and Reliance Steel & Aluminum (NYSE:RS). George has recently made some open-market purchases of the fund and currently holds about 900,000 shares directly. As of Wednesday, the fund is trading at a slight discount to its net asset value of $3.73 and charges 1.31% in expenses. While the fund has performed well long-term, it is down about 45% year-to-date.

Bottom Line
Small-cap stocks historically have proved to be the catalysts of tomorrow's economy. In turbulent economic times, long-term investors can set themselves toward profitable futures by aligning their portfolios with a specialist such as Royce and can gain some much-needed insight into particular asset classes. The preceding three closed-end funds are a great place to start for small-cap stocks.

By Aaron Levitt

Aaron Levitt is an independent investment writer and analyst living in State College, Pennsylvania. His work appears in several high profile publications in both print and on the web. Levitt is an advocate for long term investing with a global framework. You can follow his picks and pans at http://twitter.com/AaronLevitt

Filed Under: Futures

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