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RMT is a value-focused micro-cap CEF. A while back, I compared the fund to its open-ended sibling, RYOTX. Although it’s been a bad year for RMT, that’s not surprising and may actually open up a buying opportunity. The Royce family of open- and closed-end funds is managed with a bottom-up value approach. Historically, that’s been a great niche, but more recently, it’s been a performance drag. But if you are looking for a closed-end fund, or CEF, that has a value focus and invests in micro-cap stocks, I still think Royce Micro Cap Trust (NYSE: RMT ) should be on your short list. What does Royce do? The goal for every Royce fund is to find companies with strong balance sheets and the potential for above-average returns. Some of the attributes Royce looks at when examining a company include operating leverage, returns on capital, return on assets, operating dynamics, and the sustainability of its business model. Another key factor, however, makes it more difficult to find stocks to buy when the market has been heading higher for several years: Royce also wants market prices that are 30-50% below what it believes a company is worth. So it is, then, that RMT’s annualized trailing five-year net asset value, or NAV, return through August was roughly 12.8%, while the return of the Russell 2000 was a more robust 15.6% or so. By design, the Russell 2000 will have a blend of growth and value names. However, looking further back, the annualized trailing 15-year NAV return for RMT was 8.1% through August, compared to the Russell 2000’s gain of only 6.7%. (All number include reinvested distributions.) That should bring to mind the saying that the market is a voting machine over short periods, but a weighing machine over long periods. Which is exactly what RMT is all about, trying to find the stocks that have been voted “off the island” in the near term, but that still have long-term appeal. And sticking to that focus can lead the fund to underperform in bull markets. Did something just change? So far this year, it’s been no different. Year to date through August, RMT’s NAV is down 10.5% while the Russell 2000 is down only 3% or so. That’s not surprising, since, as noted, Royce sticks to its approach no matter what’s going on in the broader market. That’s exactly what a long-term investor in RMT and other Royce funds should want. But it can be hard to sit back and watch your fund underperform in the near term even though historical numbers suggest, though of course don’t guarantee, it will all turn out okay in the long term. Which helps explain why RMT’s market price declined around 14.5% through August, as investors got scared off by the laggard showing. In fact, the fund’s discount to its NAV currently sits around 15%, compared to a three-year average of around 12%. That’s a fairly deep discount for what is really a well-run fund, but shows pretty clearly that investors are worried about its performance numbers. And what about that market sell-off last month? It made things worse. At least on an absolute basis… which is worth looking at. RMT’s NAV fell 4.3% or so in August. But that marked a reversal from the trend, because the Russell 2000 fell 6.3% in the month. That’s only two percentage points, but it’s a big difference from what’s been happening recently. And once again, I’d attribute that to the fund’s value focus. Since it buys undervalued stocks, the steepening market downturn has had less of an impact. Indeed, the early-year performance of many of its holdings suggest that the portfolio had already felt the sting of the market shifting gears. In the final days of a bull market, investors tend to refocus around high-flyers, leaving other names behind. But eventually, those loved stocks also succumb when the market turns en masse. In fact, the most loved names on the upside often turn into the least loved on the downside. Value stocks, meanwhile, are usually always kind of unloved until their fundamentals shine through. But at the end of the day, RMT is trading at a wider discount than normal and has been doing better, at least on a relative basis, than the broader market as volatility has kicked up. Exactly what I’d expect from a value-focused micro-cap fund. Will it continue to hold up better? Hard to tell. But I know management will remain true to its investment focus. If we are entering a market downturn, that should serve investors well. The problem spots? So, stepping back from the last month or so of relative outperformance, what’s been going on at the fund? Looking back at the first six months of the year, lead manager Charles Royce noted that the fund’s consumer discretionary, healthcare and information technology holdings were laggards relative to the same sectors within its benchmark indexes. And that was pretty much all stock selection. For example, the fund has little exposure to biotechnology stocks, which have been on a tear in recent years. But, as Royce notes , “Most biotech companies, however, lack the fundamental attributes we seek in our holdings.” It’s the perfect example of the fund sticking to what it does, even if the market is favoring other investments. And while the next update won’t come out until after the end of the third quarter, I wouldn’t expect the theme here to change. In the end, it’s been a rough stretch for RMT. But if you have a long-term focus, don’t get too discouraged. Value investing goes in and out of favor over time, and the recent bull market, which has at least taken a breather if it hasn’t turned into a bear, has been tough for value investors like Royce. That doesn’t change the fact that RMT is a well-run fund. In fact, if you are in the market for a micro-cap value fund, now might even be a good time to start picking up some shares. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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