Unknown Mutual-Fund Firm Beats Everyone

• ByStan Luxenberg, Special to TheStreet.com
• On 5:05 am EST, Thursday November 5, 2009

NEW YORK (TheStreet) -- These are heady days for Royce Funds. Of the company's 18 mutual funds, 17 have outperformed their categories this year, according to Morningstar. All 10 Royce funds with five-year records have beaten their rivals over that period.

Part of the success can be attributed to the fund company's cautious approach. Royce managers seek out stocks with long track records for maintaining strong balance sheets. The businesses must maintain wide profit margins and rich cash flows. Such stocks have proved resilient in recent years, particularly after last year's stock-market crash separated the weak from the strong. "Our funds held up relatively well during the downturn, and then they came back quickly this year," says Whitney George, a Royce portfolio manager.

In 1972, Charles Royce bought Royce Pennsylvania Mutual, a fund he still runs. Over the years, the company has opened a series of funds that specialize in smaller stocks. Royce Total Return holds dividend-paying small caps, while Royce Premier focuses on high-quality mid-cap growth and value stocks. Royce Micro-Cap only takes shares with market values of less than $500 million.

While some of the funds fit in the growth, and growth and value ("blend"), boxes, Royce managers consider themselves value investors. They look for companies that have become temporarily out of favor and sell for substantial discounts to their fair values.

One of the top performers is Royce Low-Priced Stock, which has returned an annual average of 12% during the past decade, exceeding 96% of its small-blend competitors. Whitney George typically buys stocks that sell for $10 or less. Such companies tend to be beaten down and often overlooked, he says. "There is a stigma attached to low-priced stocks," George says. "Many institutions are required to sell anything that falls below $10 to protect against getting a goose egg."

The big market downturns pushed many solid companies into the ranks of low-priced stocks. That created plenty of buying opportunities for George. Some of his favorites are mining companies, which collapsed last year when prices of metals sank. A holding is Ivanhoe Mines, a producer of gold and copper in Mongolia. George began buying when the shares were around $10 last year -- and he held when prices fell off a cliff, reaching $2. Since then, the stock has climbed back above $10. He says Ivanhoe's prospects remain bright. "The dollar is going lower, and gold and silver will go higher," he says.

Among the steadiest choices is Royce Premier, which has returned 12% annually during the past decade, beating 99% of its peers. The portfolio includes stocks that Charles Royce considers to be the most reliable performers. Many holdings are relatively big stocks that Royce has followed for years. The fund's members have an average market value of $1.5 billion, compared with $830 million for Royce Low-Priced Stock and $245 million for Royce Micro-Cap.

Royce Premier has a big stake in manufacturers that have solid market niches. A holding is Reliance Steel & Aluminum, which makes pipes and other specialty products. Such steady choices helped prop up the fund during the downturn of 2008, when Royce Premier outperformed its average competitor by 11 percentage points.

The company's most diversified portfolio is Royce Pennsylvania, which holds about 500 stocks. Charles Royce picks a cross section of stocks that are held by all his funds, including micro-caps, dividend payers and low-priced shares. The aim is to achieve steady results in a variety of market conditions. Most often, the fund has succeeded, returning 9.9% annually during the past decade, topping 88% of competitors.

The one fund that has trailed its peers this year is Royce Total Return. The fund's small-cap dividend stocks tend to hold up nicely in downturns, but they often trail during rallies. During the past 10 years, Royce Total Return has produced middling results, outdoing 52% of competitors. But the fund ranks as one of the least volatile Royce portfolios. That makes it an intriguing option for investors who seek a stable performer.

A big holding is Ritchie Bros. Auctioneers, which sells new and used industrial equipment. Holding a big stash of cash, the company has been able to maintain rich profit margins throughout the recession.

-- Reported by Stan Luxenberg in New York.

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