Royce funds have eye for small value

Tech investment brings above-average returns

Stocks

Dollars & Sense

March 12, 2000|By Russel Kinnel | Russel Kinnel,MORNINGSTAR.COM

In "The Hitchhiker's Guide to the Galaxy" trilogy, there is a guy who is a rain god but doesn't know it. Clouds follow him every day, and it rains wherever he goes. He's so familiar with rain that he has more than 100 names for the different kinds of rain.

Chuck Royce reminds me of him.

Royce specializes in small-value stocks, a market segment that has been under a cloud since slightly after the dawn of time. Like the rain god, Royce can see 100 different gradations of small value, and he's got a fund for nearly every one. He's got a conservative small-value fund that emphasizes dividends (Royce Total Return); a conservative small-value fund (Pennsylvania Mutual) that doesn't emphasize dividends; a microcap value fund (Royce Special Equity); and small-value funds that are concentrated and ones that are aggressive.

All told, Royce & Associates runs eight small-value funds and one small-growth fund. It even had a small-cap financials fund, but it folded the tent on that one. The funds were rolled out at a steady pace during the 1990s, the last coming out at the end of 1998. Talk about misplaced optimism.

Because he's a seasoned small-value investor and I'm a ghoul, I had to ask him if he has ever seen such a great disparity between small value and growth. "No. It's the worst disparity in 20 years," he said. He remains optimistic, though. "We're buying companies with great balance sheets that are trading for seven and eight times earnings," he says. Eventually, he figures, that will matter.

Not that many investors care, but the funds have done quite well on a relative basis. All the funds with a three-year record are outperforming the small-value average by a healthy margin. One big reason is that the funds have invested a fair amount in technology even though they're stingy about what they'll pay. And their tech isn't Garrett Van Wagoner's tech. No future Yahoos or Ciscos here.

Instead, Royce funds have tech stocks like Dionex, which makes chromatography instruments. Many of the tech names were scooped up during the tech rout in late 1998. Most of their tech picks didn't put up Qualcommesque numbers, but they beat the heck out of most small-value stocks. Royce Opportunity bet enough on tech to return 32 percent last year.

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