Reviewing Royce Closed End Funds

Summary

• Three small/micro cap funds, two with managed cash distributions.
• Relatively low cost and leverage respective to most CEF's.
• Most appropriate for dividend reinvestment and dollar cost averaging.

My son, PetieK is a self admitted hypebeast. Although he's is a savvy shopper and knows how to stretch a dollar when he needs to, when it comes to name brands, there is no compromise on what's hype. If it is not hype, then he's not wearing it. (Unless it is completely unbranded, and no one else knows where he bought it.)

Source: Tyler the Creator and Glenn O'Brien from Pinterest

Supreme brand, BAPE hoodies, and Vans top the affordable list. But that doesn't mean there is not the desire for Gucci, Armani, or Off-White products. They are just not on the list of affordable brands. So, poor PetieK has to suffer with a Seiko rather than a Breitling, and Adidas rather than 10 Deep. Just don't suggest any "Dad-brands" or old stuff like Tommy Hilfiger or New Balance.

Some investors have similar attitudes when it comes to asset managers. There are "Brands" out there that have reputations that they find attractive, while others are to be avoided. Some management firms like State Street, BlackRock, PIMCO, or T. Rowe Price have good reputations while others, not so much. But when it comes to small and micro-cap, there is no more "hype" manager than Royce Funds.

Hype?

You keep using that word. I do not think it means what you think it means" - Inigo Montoya

Source:Princess Bride Poster by Matteo Doni from Flickr.com

We think of hype as a marketing strategy that is used to exaggerate the utility or value of something. But in Gen-Z slang, it is subtly different. Hype is a collection of the most savage, or the most popular. So, in that sense, Royce is certainly "Hype"

For more than 40 years, Royce funds has invested in small and mid sized companies with high internal rates of return. These companies have had to have iron clad balance sheets and proven track records of earnings and free cash flow to attract Royce dollars. Because of this, the firm's success and disciplined strategy has earned them a wide audience and brand awareness among retail investors.

We have seen Royce funds in 401(K)s, as sub-accounts in variable annuities and variable universal life contracts. They manage mutual funds recommended by many investment reps, and their no load funds are available in many retail brokerage accounts as well. However, this article is going to focus on Royce closed end funds traded on the NYSE and available through retail brokerage accounts, direct investing, and dividend reinvestment plans.

As an introductory article, we will discuss what these funds are and how they are structured and function. We will include a historical review of the funds to include both distributions and returns. Finally we will present additional information about the funds that is normally overlooked in presentations to help individual investors determine why these funds are suitable investments or not based on their particular risk tolerance, strategy, and investment timeframe.

Royce Family of Closed End Funds

First thing to point out is that all of these are closed end funds, meaning that there is a set amount of shares authorized and issued. Shares of the fund are not created or destroyed by new purchases or redemption, rather they trade just like stocks or exchange traded funds on the NYSE. In order to buy shares, one must find a willing seller on the exchange and vice versa. As a result, shares of the fund may trade at either a discount or premium to net asset value.

The second thing readers need to understand is that these are not closed end versions of Royce Mutual funds or annuity portfolios. Although there are similarly named retail mutual funds such as Royce Micro-Cap Fund (RYOTX) and Royce Small Cap Value Fund (RVVHX), the closed end funds have different investment strategies and different underlying holdings. Just because you have Royce Small Cap portfolio in your variable annuity does not mean that you are getting the same exposure by buying a closed end fund.

Next thing to point out is that although each of these funds distributes income from dividends and interest and long and short term capital gains realized, two of the closed end funds, Royce Micro-Cap Trust (RMT) and Royce Value Trust (RVT), have managed distribution plans in effect that may include a return of capital as well. Management has tried to keep these distributions at about 7% of the average net asset value over the preceding 12 months.

Finally, the funds, especially the two managed distribution funds, are designed to be "dripped". Each of the funds has an established dividend reinvestment plan with Computershare. These programs have no fees for participation and low fees for both purchases and redemptions, and participation is automatic through Computershare unless the owner specifically opts out in writing.

Royce Micro-cap Trust

Royce Macro-Cap Trust has been around since 1993 and claims to be one of the only closed end funds focused on Micro-Cap stocks, or companies with less than $1 billion in market cap. The fund is benchmarked to the Russel 2000, and has a relatively low turnover of about 20%.

Historically, the fund has performed well relative to the Russel 2000. But the way Royce presents performance stretches things a bit. Here are how Royce promotes the fund's relative performance, growth of investment, and price performance over the life of the fund.

Source RoyceFunds.Com

Sourcing the numbers directly from the annual reports, and looking at them from a slightly different perspective, and things look a little less rosy; especially when we take into consideration taxes. Assuming Shares were purchased in a taxable account at initial offering, the investor fully exercises all rights offered, and reinvested all distributions, we find:

Royce Micro-Cap Trust Total Value since Inception

Source: Data directly from SEC filings forms N-CSR 2018, 2013, 2008, 2003, 1998

Still considerable performance, relative to the Russel 2000, over the long term. But at the end of last quarter this initial investor would have had a net unrealized capital loss of $20,000 and would have paid an additional $17,000 in taxes over the years. (Assuming median marginal tax rates). However, the good news is that the shares have almost always traded below NAV, so that has been a bargain.

As mentioned above, the Royce Micro-Cap Trust portfolio does not correspond to the the mutual fund portfolio holdings. The management strategy is different, and the fund has been designed to be a long term dividend reinvestment vehicle. As such, the fund uses a managed distribution plan that is periodically modified to distribute an approximate 7% yield on net asset value over the previous 12 months. Since inception, there have been very few instances of the fund distributing return of capital to investors as opposed to strictly income or capital gains; 2008, 2009, and again in 2011.

The biggest downside to the fund is fees and expenses. However, that can be said of most closed end funds, and relative to its peers, the expenses of Royce are about average and therefore should be considered reasonable. As of last reporting, total expenses amounted to 1.35%, consisting of a 0.92 % management fee and 0.43 % other expense.

Royce Value Trust

Royce Value Trust has been around since 1986, managed by Chuck Royce from the beginning. This fund is also benchmarked to the Russel 2000, and has a relatively low turnover of about 30%.

Historically, the fund has performed well relative to the Russel 2000. But just like with the Micro-Cap Trust, the way Royce presents performance stretches things a bit. Here are how Royce promotes the fund's relative performance, growth of investment, and price performance over the life of the fund.

Source RoyceFunds.Com

Sourcing the numbers directly and looking at them from the same perspective we used on the Micro-Cap fund, and things again look a little less rosy; especially when we take into consideration taxes. But still, one can say that it has been a very strong relative performance. Assuming Shares were purchased in a taxable account at initial offering, the investor fully exercises all rights offered, and reinvested all distributions, we find:

Royce Value Trust Total Value since Inception

Source: Data directly from SEC filings forms N-CSR 2018, 2013, 2008, 2003, 1998, 1993, 1988

At the end of last quarter this investor would have had a net unrealized capital loss of $22,000 and would have paid an additional $40,000 in taxes over the years. (Assuming median marginal tax rates). Additionally, like the Micro-Cap Trust fund, shares of Royce Value Trust have most always traded below NAV.

As mentioned above, the Royce Value Trust portfolio does not correspond to the the mutual fund portfolio holdings, because the management strategy is different. This fund has also been designed to be a long term dividend reinvestment vehicle and it also uses a managed distribution plan. Similar to the above trust, the distribution is periodically modified to correspond to approximate 7% yield on net asset value over the previous 12 months. There have been very few instances of the fund distributing return of capital to investments in this trust as well; 2008, 2009, and again in 2011. Finally, the Trust spun out the last closed end fund we will look at in 2013.

The biggest surprise to this fund, contrary to the above one, is fees and expenses. Of course fees and expenses do vary over time, but as of last reporting total expenses for Royce Value Trust amounted to just 0.63%; consisting of a 0.42 % management fee and 0.21% other expense. This makes this fund very cheap relative to other closed end funds on the exchanges.

Royce Global Value Trust

The last fund we will look at is Royce Global Value Trust (RGT). As mentioned above, it was spun out from Royce Value Trust in 2013, and is also managed by Chuck Royce. This fund is benchmarked to the MSCI ACWI Small Cap index, and has a fairly active turnover of almost 60%.

Although we don't have historical data comparable to the other closed end funds, this fund has begun to perform well relative its benchmark recently. Just like with the Micro-Cap Trust and Value Trust, Royce presents performance in the exact same manner, so here is how Royce promotes the fund's relative performance, growth of investment, and price performance over the life of the fund.

Source: RoyceFunds.Com

Again, sourcing the numbers directly we can look at them from the same perspective as above, however the relatively short investment timeframe does not allow us to make definitive performance conclusions. Assuming Shares were purchased in a taxable account at initial offering and the investor reinvested all distributions, we find:

Royce Global Value Trust Total Value since Inception

Source: Data directly from SEC filings forms N-CSR 2018, 2013

At the end of last quarter this initial investor would have only had a net unrealized capital loss of $55 and would have paid an additional $83 in taxes over the years. Additionally, like the Micro-Cap Trust and Royce Value Trust, these shares have always traded below NAV as well. Not too bad considering Royce admits the fund has underperformed the benchmark since inception.

Now, unlike the previous funds, this fund does not use a managed distribution plan. But, you should also consider this fund a long-term reinvestment vehicle just like the prior ones. Historically, distributions have taken place in December of each year and have consisted only of income and capital gains, with no return of capital distributions reported.

Finally, as a global fund, it is not surprising to find that this is also a relatively expensive fund. As of last reporting total expenses for Royce Global Value Trust totaled 1.74%; consisting of a 1.25 % management fee and 0.49% other expense.

Conclusion

With over 40 years in existence, Royce and earned a reputation for being a top manager in the niche of small and micro cap funds. There is no telling if that expertise will translate to international markets with the Royce Global Value Trust fund, but they have proven their salt with their domestic closed end funds.

Retail investors should always remember that these are long term investment vehicles intended for dividend reinvestment and not short term trades. Retail investors without dividend reinvest abilities should consider the direct investment option available through Computershare rather than accumulating dividends in cash.

Finally, if an investor were to choose just one of these closed end funds, they should consider capital attrition by internal fees and select the Royce Value Trust. However, any decision you make should be based on your individual strategy, risk tolerance, and investment timeframe.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

This information is not investment advice, nor is it a recommendation to either buy or sell any securities. Retail investors should do their own research and fully understand the risks associated with this company.

Comments

[Atomic Lobotomy]

Held Royce Value Trust briefly before noticing how "dividends" were paid out--i.e. in shares, which struck me as extremely odd, given that it bills itself a CEF. From where did new shares come from? After 2 quarters of this, I bailed. Only reason for holding CEFs in my opinion is income. One does not buy CEFs for growth, value, dividend appreciation, etc. One must also be extremely selective as vast majority of CEFs lose share value over time. With that caveat, one buys them purely for the payout.

[drdata]

Receiving shares was optional. You could have received cash. Your choice. I speak as a long time shareholder. I chose shares on some occasions, and cash on others.
The shares option has not even been available for several years now.

[RockieK]

Thanks for the read and for the comment @Atomic Lobotomy. Yours proves that not all products in a category are appropriate or perfect substitutes.

[RockieK]

@drdata ,

Perhaps it is the broker/dealer who holds your shares that has discontinued the share option. To the best of my knowledge Royce DRIP is still available through direct registration at Computershare.

www.roycefunds.com/...

Not sure if you were interested, but thought I'd share nonetheless.

[HsterInvestigates]

@RockieK CEFs are worth investing for income and esp. if they beat their index counterpart like RQI beating VNQ. Since RVT underperforms Russell 1000/2000 ETFs VONE/VTWG significantly even after dripping. (Maybe VONV is a better comparison but still RVT underperforms. ) What am I missing?

[RockieK]

@HsterInvestigates . I don't think you are missing anything.

Closed end funds are unique investment vehicles that should not be directly compared to other ETP's like ETF's. However there are enough similarities that they may be substitutionary when we start talking about meeting the needs of an investor portfolio. That is where the role of individual suitability comes into play.

For one investor, the individual performance of each security relative to its benchmark is the most important metric when determining suitability. In this investor's case, selecting either of the ETF's would be more logical decision.

For another investor, uniformity and simplicity is of more importance than the bottom line; as long as that bottom line remains above a certain point. For this investor, DRIPPing the CEF at a firm where they already have assets may be a better alternative than "spreading oneself too thin" and bringing on a new/untried from/brand/manager.

For the second investor's case, the ETF is not a good substitute because it means additional accounting, record keeping, due diligence, etc. that may go well above and beyond what they deem necessary.

Hopefully that makes sense.

And, I would go so far as to say that CEF's are worth investing in if they beat their benchmark because:
- some are benchmarked wrong
- some are cleverly structured to... well let's just say that they ALWAYS make the house money, no matter what.
- some are so expensive that beating the benchmark is just not enough.

[ababich1]

Including tax as a consideration for returns is not appropriate because each individuals tax circumstances are different. It leads me to believe that this is a hit piece.

[RockieK]

Not a hit job. But @ababich1, I made you think about taxes.

My job here is done.

Thanks for the read.

[bobholt]

I've held RVT since the end of May 2018. I calculate return per year for all of my holdings and RVT gives me 7.3%. It is one of my few small cap holdings and I'm going to hold.

[RockieK]

@Holtgraver, that's a very short holding period for an investment like this. If you are underweight in the asset class, is there anything holding you back in adding to it?

[bobholt]

@RockieK
Thanks for the thought. I probably will add to it significantly when I get some cash. (Retired and using Div Reinvest).

[MathRulz]

FYI—“Inigo” Not “Indigo”

[RockieK]

Thank you @MathRulz . My autocorrect keeps changing it from the name to the color, so I've asked SA to fix it for us.

[Mr_Kurtz]

to add to that last comment - soon the only investors left in roycefunds will be the employees themselves. future bagholders for sure.

[Mr_Kurtz]

fees are exorbitant compared to the value/service being offered. royce has lost more than 50% of its $AUM in the last 5 years, and the talent that was laid off hasnt been replaced by anything meaningful. not sure how they can still afford rent on 5th ave nyc. they own some good assets but they are managed extremely poorly. pass.

[RockieK]

Thanks for the read and comment @Mr_Kurtz . You are very correct that Brand does not equate to value. And I'm not sure how anyone can afford rent on 5th Ave.