Lauren Romeo is at the helm of this $203m (£135m) fund investing in US smaller companies, which she defines as stocks with a market cap of less than $5bn.
Ms Romeo says: “The fund’s investment objective is long-term capital appreciation, which we try to achieve by buying high-quality, primarily US smaller-cap companies that we believe can compound business value at above-average rates of return for at least the next three to five years.”
The fund was launched in 2004 and the manager points out one of its strengths is its consistent investing discipline, regardless of the market environment. Ms Romeo runs a concentrated portfolio of just 69 holdings as a result. She explains: “We try to identify and invest in companies that have defensible, sustainable business models and competitive positions enabling them to generate above-average or improving returns on capital.”
Strong balance sheets and good free cashflow generation are also common attributes of the stocks held in the portfolio. The manager adds: “By buying when firms are out of favour for what we believe are temporary cyclical or company-specific reasons, we try to build in a margin of safety on the downside that yields an attractive risk-reward return profile for the individual stocks and the portfolio as a whole.”
While Ms Romeo and her investment colleagues “pay attention” to wider macroeconomic issues, she admits these concerns do not end up playing a major role in the security selection process. She notes: “The fund uses an intensive research process focused on individual companies and their industries to select stocks. We believe this focused approach allows us to uncover investment insights that other macro-oriented investors may miss.”
This year Ms Romeo has been increasing the vehicle’s weightings in consumer discretionary and financials stocks, although industrials and IT remain the biggest sector weightings. This is on the basis that these sectors continue to offer the most attractive valuations among “quality” US small caps. “They are cyclical but steadily profitable and should drive faster sales and earnings growth on an absolute and relative basis as economic growth improves,” she adds.
The key investor information document for the clean fee X-accumulation share class shows an ongoing charge of 0.98 per cent applies to the fund, which is ranked at level six on a risk-reward scale and is considered a higher-risk investment as a result.
The fund has failed to outperform its benchmark, the Russell 2000 index, data from FE Analytics shows. The vehicle delivered 28.7 per cent in the three years to December 2, compared with the 60 per cent rise in the index. It also suffered in the past year with a loss of 1.1 per cent, while the index climbed 7.9 per cent.
Ms Romeo acknowledges the portfolio has lagged its benchmark and suggests low exposure to healthcare stocks, particularly biotechnology firms, earlier in 2015 hurt relative results. But she points out: “This began to shift a bit in July. The fund did slightly better than its benchmark in the more volatile and bearish third quarter as more companies with earnings gradually began outperforming non-earners, a trend we think should continue.”
She concedes that financials holdings and those specialising in semiconductor manufacturing detracted most from the vehicle’s performance in the past year. “Holdings in financials suffered most relative to our benchmark. This was largely the result of the fund’s underweight in banks, an area we typically avoid. The portfolio’s overweight in semiconductors and semiconductor equipment companies also hurt results through the first 10 months of the year, as did the fund’s overweight in the energy sector.”
In spite of a tricky few months, the manager says individual stocks, rather than specific sectors, have worked well so far this year. “Year to date to the end of October, a few holdings in the consumer staples sector did well, most notably Cal-Maine Foods, the largest producer of eggs in the US. In the industrials sector, John Bean Technologies [performed] well owing to robust demand for its food processing and air transportation equipment and services.”
EXPERT VIEW
Lena Tsymbaluk, manager and research analyst, Morningstar
This fund holds a Morningstar analyst rating of Bronze, and benefits from Royce’s long and established heritage since 1972 of investing in small-cap US stocks. Legg Mason’s trademark process seeks out companies that are 30-50 per cent underpriced relative to their view of the current worth. This value-leaning, benchmark-agnostic approach leads them to be contrarian and often results in a return profile that deviates significantly from that of the index. The fund’s recent concentration in cyclical areas has worked against it as investors have avoided those areas due to heightened fears of a slowdown.
