Willing to Wait… But for How Long?
analysis, mutual fund

A recent article on Barron’s profiles Chuck Royce, the manager of the Royce Pennsylvania Mutual Fund for over 40 years. According to the article:

“The senior fund manager, 73 years old and regarded as a top small-cap investor, blames the Federal Reserve and its quantitative-easing program for distorting values in the stock market… For New York-based Royce, investing has always been about following a discipline. Those investors so eager to bolt for funds posting better returns should consider whether their new portfolio managers can match Royce’s 30-year record of 11.54% a year as of the end of the first quarter, versus 9.39% for the Russell 2000, or the 11.18% a year he’s managed over the past 10 years through May 8, better than 80% of all small-cap funds… In the short term, Royce hasn’t done as well. For the year through May 8, the fund’s 11.22% gain is worse than 81% of the small-cap funds tracked by Morningstar. Year over year, Royce posted a 19.75% rise, well behind the Russell 2000’s 24.17% gain.”

With that, how does the fund’s performance in the past eight years look from the Alpholio™’s perspective?

Cumulative RealAlpha™ for PENNX

The chart reveals two distinct phases in that period:

  • From early 2005 through late 2009, the fund largely did not generate any RealAlpha™
  • From 2010 onwards, the fund exhibited a negative trend in cumulative RealAlpha™.

In its analysis of the fund titled “Royce’s flagship fund is a contender,” which was published in November 2012, Morningstar states that:

“The past few years have been uninspiring, but Royce Pennsylvania Mutual still has what it takes to succeed in the long term.”

The questions are: How long will the fund take to recover? Will it ever outperform its reference exchange-traded product (ETP) portfolio? The above chart does not offer an encouraging answer to either question.


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Analysis of Royce Special Equity Multi-Cap Fund
analysis, mutual fund

Royce Special Equity Multi-Cap Fund (ticker symbol RSEMX) is a mutual fund with approx. $136 million in assets managed by Charles Dreifus, CFA. Currently, Morningstar gives the fund an analyst rating of Bronze in the US OE Large Blend category (the reason for no star rating is that the fund is not yet three years old). The latest Morningstar report on the fund, titled “Its positive traits outweigh a hefty price tag” was published in March 2013. At present, this no-load fund has an expense ratio of 1.39% (after 0.58% in fee waivers and/or expense reimbursements) and charges a 1% redemption fee on shares held less than 180 days. Let’s explore the fund’s performance using the Alpholio™ methodology.

First, the total return chart, which assumes reinvestment of all distributions into the fund and each member of the reference portfolio, respectively:

Royce Special Equity Multi-Cap Fund

Since the fund’s inception was only at the end of 2010, the overall analysis period begins in April 2011. The chart shows that in this relatively short history period, performance of the fund was generally matched or exceeded by that of its reference portfolio.

This is further illustrated by the cumulative RealAlpha™ chart:

Cumulative RealAlpha™ for RSEMX

In the chart, the lag cumulative RealAlpha™ curve follows, for the most part, the regular RealAlpha™ curve (the offset stems from the one-month lag at the beginning of the analysis period). Typically, this is an indication that the fund manager did not make any major directional bets that significantly departed from the fund’s holdings in the immediately preceding time window. The chart also indicates a recent negative trend in cumulative RealAlpha™.

The overall statistics further underscore the unimpressive performance of the fund:

RSEMX Statistics

At about 13%, the fund’s volatility, measured by an annualized standard deviation of monthly returns in the entire analysis period, was lower than that of the overall stock market. The volatility of the reference portfolio was lower than that of the fund. This typically indicates that the fund was sufficiently diversified and contained positions generally present in the reference exchange-traded products (ETPs). The discounted annualized RealAlpha™ of the fund was approx. negative 2%, which was mostly caused by a loss of alpha in the past 12 months. At about 0.95, the fund’s RealBeta™ was slightly lower than that of the market, which was also reflected in the lower volatility.

The following chart demonstrates the use of smoothed RealAlpha™ to automatically generate a hypothetical trading signal for the fund:

Buy-Sell Signal for RSEMX (EMA)

The analysis starts with an assumption that the investor initially bought the fund in early 2005 and intended to hold this investment indefinitely, i.e. at least through early 2013. The blue curve depicts the cumulative RealAlpha™ in that entire period. Since there is some degree of high-frequency oscillation in that curve, its longer-term trend can be elicited from its smoothed approximation with an exponential moving average (EMA), depicted by the green curve. Subsequently, a simple decision criterion is applied to determine whether the investment in the fund should be retained. As long as the fund generates positive monthly increments to cumulative RealAlpha™, the investment in the fund is considered beneficial. Conversely, if the fund’s cumulative RealAlpha™ begins to consistently decrease, the investment is no longer considered attractive.
The signal would allow an investor to avoid the recent period of the fund’s underperformance according to the smoothed RealAlpha™ measure.

The following chart shows the major investment “themes” of the fund over time:

Reference Weights for RSEMX

In the analysis period, the fund held equivalent equity positions in IYJ (iShares U.S. Industrials ETF; average weight of 22.4%), IYC (iShares U.S. Consumer Services ETF; 20.2%), IYW (iShares U.S. Tech ETF; 13.9%), IYK (iShares U.S. Consumer Goods ETF; 9.4%), IYH (iShares U.S. Healthcare ETF; 7.4%), and IVE (iShares S&P 500 Value ETF; 6.3%).

For clarity, smaller reference positions are collectively represented by the Other category in the chart. For example, this category includes an equivalent cash position in SHY (iShares 1-3 Year Treasury Bond ETF; average weight of 5.5%). This indicates major market timing efforts in the fund an investor would reasonably expect to be predominantly invested in equities.

While the Morningstar analyst report says that

“Good defense should help Royce Special Equity Multi-Cap succeed.”

Similarly, a recent Wall Street Journal article projects a bright future for the fund based on the manager’s experience at another fund. Only time will tell if these forecasts prove true.

In the meantime, this analysis clearly demonstrates that the strategy of the fund could easily be replicated using a relatively small number of exchange-traded products (ETPs), and with a better performance (higher return with smaller volatility). Investors could use the results of the ongoing Alpholio™ analysis to construct a substitute portfolio of liquid, low-cost instruments that provide a higher diversification (as of this writing, the fund holds only 30 securities) and do not impose a long minimum holding period.


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